Buying a business offers the opportunity of exploiting the potential of a recognized brand with an existent customer base that is ready to start operating.
However, purchasing a business is a hefty investment for which you will probably need a loan. Here’s a comprehensive guide on how to finance your business acquisition:
1. Verify Your Eligibility
Lenders are going to risk their capital for companies that have high probabilities of success.
For that reason, it is easier to get a loan when you are able to prove the business you want to purchase has a good performance and that you are a business owner with experience and an acceptable reputation.
These are some factors that may affect your eligibility to get funds:
Personal credit and experience
Lenders are going to evaluate your ability to manage debts to conclude whether you will have a satisfying performance in the future. Both your personal and business finances can have an impact on your advantage to get a business loan.
Personal credit score: A credit score is a number from 300 to 850 that lenders use as a reference to understand how likely to are to pay a loan back in time. Your personal credit score is tied to your Social Security number.
Your credit score is based on your bill-paying history, your current unpaid debts, the number of accounts, and related financial information. Another factor that impacts your credit score is whether you have experienced bankruptcy or foreclosure and how long ago.
A higher score makes it easier for you to be eligible for a loan with better interest rates and favorable terms.
You can check your credit score by:
- Checking your credit card or other loan statement
- Talking to a non-profit credit counselor
- Using an online credit score or service
- Buying a score from credit reporting companies
Personal finances: Lenders typically request the following documents:
- Personal bank statements
- Tax returns
Business experience: Your experience as a business owner will bring a positive image in the eyes of lenders. If the business you want to buy is related to your area of expertise, or have related education, this can help you get a loan.
Past business performance
Having a history of operating successful businesses can ease the lending process. Make sure to prove your managerial abilities with records of your owned businesses.
Financial statements: Prepare financial documents that will show the profitability of businesses that you have owned in the past, such as:
- Financial statement (including income, balance sheets, profit margins, and cash flows)
- Business tax returns
- Business bank statements
Business credit score: As well as for individuals, a credit score is applied for businesses. Most business credit scores are ranked on a scale of 0 to 100, and it is tied to your Employer Identification Number (EIN).
The credit score of a business is determined using its payment history and debt usage, but also the industry risk and company size.
Target business past performance
Some entrepreneurs want to buy a business that is performing poorly to prove their management skills and see if they can make it work. In general terms, this is a bad idea, but when it comes to getting funds to purchase a business, it is even worse.
Financing companies will be more cooperative to borrow money for valuable acquisitions, so you need to ensure the business has a high potential for profitability.
It may sound too much of a bother to request all these documents from the business seller, but it is essential information for the lender, and also for you. When you conduct due diligence, this information is going to be useful to decide whether this is a wise investment.
For the business owner is going to provide sensitive information, you may be asked to sign a non-disclosure agreement (NDA) to demand your confidentiality.
Financial statements: To demonstrate the optimal performance of a business, gather the following financial documents
- Cash flow
- Profit and loss
- Balance sheets
- Tax returns
- Business bank account statement
- Past due debts and liens
- Time in operation
Business valuation: It is beneficial for you and the lender to know the real purchase price of the target business. An independent business evaluator can help you assess the business’s worth. The following are three methods to appraise a company:
- Market-based valuation: Determines the price of the business by comparing it to other companies in the industry.
- Asset-based valuation: The price is based on the company’s net asset value. It examines tangible items, such as equipment and real estate, and intangible, such as trademarks and other intellectual property.
- Income-based valuation: With this method, the appraisal depends on the estimated cash flow projections.
2. Prepare Your Documentation
Before going through your list of choices, you need to prepare the documents that lenders are likely to request.
The following are the documents that lenders typically require to evaluate your finances and the performance of the target business:
The following documents help lenders asses your personal finances, your management experience, and your plans for operating the business after its purchase.
- Financial statements
- Social Security number
- Business financial statements of the businesses you have run
- Income Tax returns
- Loan application history
These documents will be provided by the current business owner, and they prove the performance of the business you intend to buy
- Business license or certificate
- Business tax returns
- Business balance sheet
- Proposed bill of sale
- Business lease agreement
- Incorporation documents
- Asking price with included assets
- Employer Identification Number
- Purchase Agreement
- Letter of Intent
- Proof of equity injection
- Professional business valuation
- Cash flow projections
3. Choose A Type Of Loan To Purchase Your Business
There are several entities that can lend you money for a business acquisition. Below, we will discuss the types of loans you can apply to for a business acquisition.
Traditional term loan
Traditional loans are the ones issued by banks and credit unions. A term loan offers you the opportunity of borrowing a fixed amount of money and pay back the loan at a specific period and typically at a fixed interest rate.
Traditional loans are the most resorted kind of financing for business acquisitions because of their capacity to cover the costs of the purchase and their long-term nature.
These loans tend to offer the advantage of low interest rates and favorable terms, however, the eligibility criteria are more rigorous.
For this reason, if you plan to ask for a term loan, it is better to ensure your credit score, business experience and value of the target business are in optimal conditions.
Online business loan
If you want to buy a business, you will be able to find dozens of online sites that offer loans for this purpose.
Online financing platforms are more flexible when it comes to their eligibility requirements. With a credit score as low as 600, you can still qualify for an online loan that will be quickly approved. But all this apparent easiness comes with a price: online loans usually charge higher interest rates than traditional term loans
A loan offered by the Small Business Administration (SBA) is suitable once you have exhausted all your financing options. The SBA helps small businesses get funding by connecting them with lending partners.
The Small Business Administration guarantee a major portion of the loan amount and reduces the risk of loss for the lenders, which is why it is easier to qualify for financing.
Some SBA partners include:
- Credit unions
- Community Development Organizations
- Micro-lending institutions
The most common loan in a business purchase is the SBA 7(a) loan program, which can help you purchase equipment, real estate, supplies, and other physical assets.
How to get an SBA loan
- Use the SBA’s Lender Match Tool to find a lender in your area
- Answer a couple of questions regarding your business
- Get a match within two days. You will receive an email with the contact information of interested lenders
- Compare the rates, terms, and fees of the different lender proposals.
- Submit loan application and paperwork.
The SBA also provides a list of approved private lenders to which you can apply directly, and they can give you information on the various types of business loans, such as term loans, microloans and lines of credit.
You can also apply to an SBA 7(a) loan through a local bank that is partnered with the government agency.
General Terms and Fees
- Loan amount of from $50k to $5 million
- Interest rates to 9% to 10.75%
- Loan term from 10 to 25 years
- When the loan is approved, all available business assets will be collateral. If the value of the company’s assets are not enough, the SBA may register personal real estate as collateral.
- Most of them ask to be repaid through fixed monthly payments of principal and interest
- You must have used alternative finance resources, including personal assets, before seeking financial assistance.
- Minimum personal credit score of 670. A higher score may increase the odds of getting a loan.
- No bankruptcies in the past three years
- Personal financial documents, tax returns and personal assets.
- A lender might require a 10% down payment
- Clean criminal history
- No outstanding business debt
- Industry or managerial experience
- Must be a small business in the United States. As defined by SBA, it should be a privately-owned enterprise with 500 or fewer employees.
- The business cannot be involved in lending, rental real estate, investing, or speculation.
- Business financial documents that prove the company’s cash flow, operating expense, and physical assets.
- The target business should be operating for at least two to five years
If the other party is willing, you can settle an arrangement to have the seller finance the purchase of the business. Seller financing allows the buyer to pay off a portion of the price of the business at a specific period with interest.
In this case, you will need to sign a loan agreement that specifies the terms of the loan, such as the interest rate, payment amount, fees, late payment penalties, etc.
When available, this might be your most feasible choice, as you can get affordable rates and exceptional financing terms. However, you still have to share your personal finances and a personal guarantee to prove you are a reliable borrower.
4. Look For Other Financing Options
Although you will surely need a loan to buy a business, it is better to look for other methods that can complement your financing and reduce your debt.
Other business acquisition financing options include:
Assumption of debt
Another way of financing your business acquisition is assuming the company’s existing liabilities. This can include loans and trade payables. The liabilities you are going to assume depend on how you negotiate the sale. It’s important to notice that some debts require the lender’s approval to be transferred.
By using this method to finance your business purchase, you avoid having to pay back the money. Instead, the investor will apport capital in exchange for an ownership share and being involved in the operations of the company.
Personal funds and relatives’ assistance
The most obvious and easiest source of financing is using your own money. The most recommended thing to do is to only use money that you can afford to lose. It is not advised to mortgage your home to make an investment.
Best practice is to fund the down payment with your personal funds and choose other ways to finance the remainder.
You may opt for using 401k assets as an investment. Using your retirement money is risky, for it can involve the danger of losing the business and tax penalties. If you have a 401 (k), you can either withdraw funds, take a loan against it, or transfer your balance into a ROBS (rollovers as business startup) account.
Family or friends
Although it can seem like the easiest resource, asking a loan to your dearest ones can have serious consequences on your relationships. Assess the risk before asking them for money as a gift, in exchange for equity in the business, or as a loan.
You can have others contribute to your business acquisition through crowdfunding. This practice gives exposure to your new project through online platforms and allows you to bring investors that can help you raise hundreds or even thousands of dollars.
5. Submit Your Application
Depending on the lender service you opt for, you will be ready to submit your application online or in person. The lender will require additional information to verify if you are qualified for the financing, such as:
- Your name
- Business Name
- Desired loan amount
- Collateral and down payment information
- The purpose of the loan
- Business tax ID
- Annual revenue
It’s essential that you can provide a clear answer to the following questions:
- What do you need the money for?
- Why are you trying to buy this business?
- How will you repay the loan?
- How quickly do you need the money?
How hard is it to get a business acquisition loan?
The difficulty of getting a loan to buy a business depends mostly on three factors: your personal finances, your business experience and the performance of the business you intend to purchase. A good personal credit score and optimal financial projections of the business can increase the possibilities of getting a loan with good terms.
Can I buy a business with no money?
Most lenders will ask you a down payment of at least 10%. There are specific loan options that do not require a down payment, but it is likely that those services will have high interest rates.
If you don’t have money to buy a business, you can opt for other financing options, such as crowdfunding or applying for grants.
Which loans can I use to buy a business?
There are several lending options for business purchases, such as:
- Traditional term loans
- Online term loans
- SBA loans
- Equipment financing
- Seller financing
Can I get a business loan with bad credit?
Although a bad credit will reduce your possibilities of getting a loan, you can still find banks and institutions who are willing to lend you money. However, these options may come with not so favorable terms.
How many years is a loan to buy a business?
Business loan terms vary by lender and loan type. SBA loans offer a range from 7 to 25 years.