Top 4 Loans to Buy an Existing Business
December 10, 2019 | Last Updated on: July 21, 2022
December 10, 2019 | Last Updated on: July 21, 2022
Loans to buy an existing business may differ from other types of business loans in several ways. A business acquisition loan is a specialized class of loan that focuses primarily on the cash-flow and assets of the target company.
Whether you want to expand your business, mitigate competition, or simply start a new venture, the decision to buy an existing business is frequently used by entrepreneurs and businesses alike. The acquisition of a business can open doors to new markets quickly and provide tremendous ROI compared to other investment channels. If you canâ€™t cover the cost of acquisition or want to maintain flexible cash flow, there are several borrowing options available. In this article, we will outline the most common loans used to buy an existing business, as well as other things you may need to know about this process.
Before you jump into any sort of loan application, you will want to get a thorough understanding of not only your own finances and credit, but also that of the business you plan on acquiring AND your current business. This will require a bit of work, but it will allow you to identify which loan is the best fit for you. Doing so also informs you on whether the purchase of this business is actually going to be worth it. As the borrower, it is your job to convince the lender that you are creditworthy, so it is in your best interest to do it properly.
When it comes to personal finances, you will need to be familiar with a lot more than just your credit history. If you are a new business owner, know that this information will be even more heavily scrutinized. Here are some things you will need to provide to a lender, or at least be cognizant of:
In addition to financial information, a lender will want to know what you specifically bring to the table. Are you going to provide some benefit to the business that it did not have before? Have you worked in the industry before? There are many things a lender will want to know before providing financing, here are a few:
Just as important as your personal finances are the finances of BOTH the business you plan on purchasing and, if applicable, your current business. A bank or other lender will need to know how capable you and your business are of repaying debts, as well as your ability to weather tough times. Any lender will need to know, at the very least, the following:
While you will likely need to take out some sort of loan in the end, it is prudent to evaluate other avenues first as they may provide cheaper financing. Putting up personal capital is the easiest way to provide payment. This may involve the sale of personal real estate or other assets. Having some of your own skin in the game is also the best way to signal to lenders that you are truly invested in the project.
Beyond personal investment, one of the best ways to raise funds is through family and friends. People close to you are likely willing to offer capital well below market rates. They are also apt to scrutinize your finances less than an institutional lender, such as a bank. In addition to being a cheaper form of financing, this may be one of the only options for high-risk borrowers.
If the channels above are insufficient, which they are likely to be, a loan may be in order. While there are no specific business acquisition loans, there are several loan options that can be used for this purpose.
A loan utilizing the Small Business Administration (SBA) is by and large the best option for small businesses and entrepreneurs. An SBA loan is not actually provided by the SBA. Rather, the SBA guarantees up to 85% of the loan in the case that the borrower defaults. By guaranteeing a majority of the loan, the SBA drastically reduces the traditional lenderâ€™s risk. In turn, the bank can offer the borrower much better terms. For the purpose of this article, we will be referring to SBA 7(a) loans. Though there are around a dozen different SBA loans, the 7(a) is the most frequently used and the best for the purchase of a business.
Because SBA Loans are largely guaranteed by the small business administration, they typically offer higher loan amounts, lower rates, and longer terms. Additionally, the limited risk means that the borrower is not required to have as much collateral. For smaller SBA loans, there is no need to provide personal collateral at all. The SBA site even states, â€śthe SBA will generally not decline a loan when inadequacy of collateral is the only unfavorable factorâ€ť. Further, where conventional loans must be directed towards some specific stated purpose, SBA loans can be applied to a variety of business purposes. SBA Loans are ideal for small business owners seeking to make small to medium-sized acquisitions.
While an SBA Loan offers better rates and is generally more available to borrowers than other loans, the loan application process can be quite cumbersome. In a conventional loan, the borrower must simply satisfy the bankâ€™s requirements. With an SBA Loan, the borrower must also satisfy the governmentâ€™s requirements. As a result, SBA Loans can take much longer to obtainâ€”sometimes taking several months. SBA loans are also most appropriate as a small business loan given their somewhat low upper limit.
A conventional business loan is the standard business loan offered by a bank or other lender, such as a venture capital firm. With a conventional loan, the lender provides some amount of money that must be paid back at a pre-set term and for a typically fixed rate of interest. For purchasing an existing business, these can be one of the only options for large-scale acquisitions.
Conventional loans, being less regulated, are more flexible than SBA Loansâ€”which typically follow more rigid guidelines. These loan programs are one of the only options for business acquisitions exceeding $5,000,000. If you already have a healthy relationship with a bank, you may be able to get better loan terms than under an SBA Loan. Bank Loans may be the best option for an acquisition with a high purchase price. Finally, because these loans need to only meet the lenderâ€™s requirements, the process can be quicker than the SBA Loan process.
Because these loans are not guaranteed by the government, it typically is harder to obtain and has stricter requirements. For small business ventures (i.e. <$5,000,000), these loans are essentially an SBA Loan without the governmentâ€™s guarantee. As such, a traditional bank loan should only be utilized in the case of a larger purchase.
If you want to buy an existing business but don’t think you would qualify for conventional financing, there are a few alternatives. For individuals and businesses unable to meet the stringent requirements of the SBA or Conventional Loans, some sellers will be willing to conduct the sale of the business as a loan. In this instance, the buyer would reach an agreement with the seller in which they would provide a certain amount of money as down payment with the remainder being paid over an agreed-upon period of time and at some rate of interest. The terms and requirements of these â€śLoansâ€ť are determined entirely by the participating parties.
Financing an acquisition through the seller can go a number of ways. Therefore, nailing down any definitive costs or benefits is difficult. However, because each instance is different, seller financing could potentially provide the best terms. If the seller is seeking to sell quickly and is not concerned about receiving all of the payment immediately, they may offer very low interest rates. Seller financing is also not required to pass through the same institutionalized channels as most loans and could, therefore, be processed much quicker.
A seller may see your request for seller financing as a signal that you are unable to secure other loans, and increase their rate accordingly. Thus, seller financing can end up being quite expensive.
Rollover for Business Startups is a little-known option for entrepreneurs and small businesses. It involves withdrawing oneâ€™s funds from their 401k and putting them towards a business venture. Because this method does not require any monthly payments, it is technically not a loan. Nonetheless, it can be a valuable business financing option for entities unable to secure a more traditional bank loan.
ROBS has minimal requirements and does not require credit, collateral, or other traditional requirements. ROBS also avoids the early withdrawal fee normally imposed on the use of 401k funds and is un-taxed. Putting your own retirement on the line can also give financial institutions a sort of personal guarantee of goodwill, and result in lower interest rates and more favorable loan terms. ROBS can also be utilized to cover some of the working capital or equipment financing required when the new business is acquired.
By withdrawing your retirement savings, you are risking the loss of any retirement money. When this money is withdrawn from the account, it will no longer accrue gains or compound. While ROBS may avoid taxes and government fees, hiring a ROBS provider or attorney can be very expensiveâ€”and the funds withdrawn cannot be used to cover these expenses. ROBS is also constrained by the amount you have in savings, and may not be enough to cover the acquisition.
The decision to buy an existing business can be a great way to grow your company. However, most small business owners do not have the capital or lines of credit required. For business owners with good credit scores, an SBA Loan is the best option as it provides superior loan terms. An alternative to an SBA loan is a conventional term loan. However, these loans typically offer worse terms and should only be used for large business purchases that an SBA cannot cover, or if you have no access to funds for a down payment and are willing to accept very high rates. If one is unable to secure either of these loans, they can sometimes reach an agreement with the seller. However, many sellers will want their payment upfront or will charge high rates. If one lacks the funds to pay a down payment, they have the option of withdrawing their retirement savings. This is very risky but can provide much-needed cash if borrowing is not a feasible option.