Top 4 Financing Options for Buying a Business

What are the best loans for buying a business

When it comes to buying a business, most entrepreneurs aren’t paying cash. Instead, they are using loans to buy an existing business. Financing the purchase of an established business can be helpful because it splits up the cost over an extended period, rather than requiring a lump sum upfront. Plus, it opens the possibility of business ownership for countless individuals who would otherwise be unable to purchase an existing company.

In this article, we will outline the most common types of financing used for buying a business, and consider a few other things that would be helpful to know if you’re thinking about business ownership.

Starting the Process

The first step in buying a business is ensuring you understand the company you’re interested in acquiring. That means doing your own due diligence (don’t just rely on a business broker). You’ll want to request their financial documents, clearly understand all business assets and liabilities, and have an accurate business valuation.

From there, it’s time to look at financing options. Before you get financing to buy a business, you’ll want to have a thorough understanding of your personal and (if you already own a business) business finances. As the borrower, it is your job to convince the lender that you are creditworthy, and to do this, you need to know your financial standing.

Personal Finances

If you are a new business owner, there are some things you will need to provide to a lender, or at least be familiar with:

• Personal Credit Score
• Tax Returns
• Outstanding Debts
• Cash Flow
• Collateral

In addition to financial information, a lender will also want to know what else you bring to the table. For example:

• Business Plan:
• Industry Experience
• Past Entrepreneurial Experience
• Personal (or Business) value adds

Business Finances

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:

• Business Credit Score
• Cash Flows
• Financial Statements
• Past Company Performance
• Business Tax Returns
• Balance Sheet
• Other Collateral

Which Financing Option is Right for You?

With those loans covered, let’s look at some of the options available whether you want to use alternate financing or a loan to purchase an existing business:

1. SBA Loan

Small Business Administration (SBA) loans can be a good option for small businesses. 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 lender’s risk. In turn, the lender can offer the borrower better terms. For this article, we will be referring to SBA 7(a) loans. Though there are around a dozen different SBA loans, the 7(a) is a strong choice for purchasing a business.

SBA Loan Terms:

• Loan Amount: $5,000 – $5,000,000
• Loan Term: 5 – 25 Years
• Interest Rates: Lenders and borrowers negotiate the interest rate and there is no SBA maximum interest rate limit.
• Fees: Typically, 1 – 3.75%, varies with guaranteed amount and loan term

SBA Loan Requirements:

• For-Profit Business
• Conducts Business in the US
• Must have explored other options, including personal finances
• Personal Credit Score >680
• Down Payment: >10-20%
• Sufficient Collateral

Advantages

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 even states, “the SBA will generally not decline a loan when the inadequacy of collateral is the only unfavorable factor.” 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.

Disadvantages

While an SBA Loan offers better rates and is generally more available to borrowers than other loans, the application process can be quite cumbersome. In a conventional loan, the borrower must simply satisfy the bank’s requirements. With an SBA Loan, the borrower must also satisfy the government’s requirements. As a result, SBA Loans can take much longer to obtain—sometimes taking several months. SBA loans are also most appropriate as small business loan given their somewhat low upper limit.

2. Conventional Business Loan

Banks offer business loans to buy an existing business. 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 Business Loan Terms

• Loan Amount: Negotiated with lender, typically $25,000 – $500,000
• Loan Term: Negotiated with lender, typically 1-5 years
• Interest Rates: Average 7% for urban and 8.3% for rural fixed term loans (non APR), but rates may vary lower or significantly higher.

Conventional Business Loan Requirements

• Excellent business and/or personal credit
• Minimum annual income level
• Sufficient collateral

Advantages

Conventional loans are more flexible than SBA Loans—which typically follow more rigid guidelines. These loan programs are one of the only options for business acquisitions exceeding $5,000,000. Finally, because these loans need to only meet the lender’s requirements, the process can be quicker than the SBA Loan process.

Disadvantages:

Because these loans are not guaranteed by the government, they typically are harder to obtain and have stricter requirements. For small business ventures (i.e. <$5,000,000), these loans are essentially an SBA Loan without the government’s guarantee.

3. Seller Financing

If you want to buy an existing business but don’t think you would qualify for conventional financing, there are a few alternatives. Some sellers will be willing to conduct the sale of the business through seller financing. In this situation, the buyer would reach an agreement with the seller in which they would provide a certain amount of money as a down payment, with the remainder being paid over an agreed-upon period and at some rate of interest. The terms and requirements of these “Loans” are determined entirely by the participating parties.

Advantages

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. Some sellers may agree to continue being involved with the business over a period of 6 or 12 months to make the transition smoother.

Disadvantages

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. Also, under some agreements, if you fail to make payments, the business may revert back to the original owner, so you would be out whatever cash you had paid.

4. Rollover for Business Startups (ROBS)

Rollover for Business Startups is a little-known option for entrepreneurs and small businesses. It involves withdrawing one’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 Requirements

• The business in question must be a “C” Corporation
• The entrepreneur must have a suitable 401k account or traditional retirement savings
• An Attorney or ROBS Provider must facilitate the withdrawal

Advantages

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 untaxed. 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.

Disadvantages

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 an ROBS provider or attorney can be very expensive—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.

Conclusion

Buying a business can be a great way to fulfill your dream of becoming an entrepreneur or growing your existing company. However, most small business owners do not have the capital required. For business owners with good credit scores, an SBA Loan can provide excellent terms, but a conventional loan may be faster and easier to get. Alternatively, seller financing may be an option that comes with additional benefits. Finally, some may consider pulling from their retirement savings to make an acquisition, but this can be very risky.

FAQs about buying a business

What are the best financing options for buying a business?

The best financing options for buying a business generally include SBA 7(a) loans, term loans, seller financing, and rollover for business startups (ROBS). Consult with a professional before making a selection for your specific situation.

How do SBA 7(a) loans work for buying a business?

SBA 7(a) loans are backed by the Small Business Administration and have favorable terms, like loan amounts up to $5 million, repayment terms up to 10 years, and competitive interest rates. Contact your lender to see if they offer SBA 7(a) loans.

What is seller financing and how can it help when buying a business?

Seller financing is when the current owner of a business agrees to finance the sale of their business. This can reduce the amount of outside required funding to buy a business and may let the new owner maintain a closer relationship with the seller, which can help smooth the transition with employees and the customer base. This is especially important if the current owner has a strong track record with them.

Can I use a business line of credit for buying a business?

A business line of credit offers flexible funding and could be used to purchase a business. However, lines of credit may not be large enough to fully finance a business purchase, and the interest rates and terms may not be as favorable as you might get if using a loan to buy a small business.

What should I consider when researching financing for buying a business?

When considering financing for buying a business, to make an informed decision it’s important to consider the loan amount available, interest rates, repayment terms, financing processing time, and the expected ROI of buying the business.

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