Unless you are individually wealthy, you will need to find a way to finance the purchase of a business. In today’s day-and-age there are a vast amount of financing options, but in this article, we will cover a few of the more common ways to finance a business deal.
Traditional Business Loan:
One of the more well-known options is to take out a term loan through a financial institution such as a bank. However, this can be one of the more difficult options. Banks lend funds against existing assets and not against a “solid business plan”. Therefore, in order to even qualify for a loan, you must have good personal credit, qualifiable experience in the industry and an adequate amount of assets.
Small Business Administration Loan:
If conventional lending is the only option available and you do not meet the qualifications for a traditional loan. One of the more advantageous alternatives is to apply for a 7A Loan through the SBA. The SBA itself does not lend the money but rather, provides certain guarantees and safety measures for the bank who is actually funding the acquisition.
Typically, borrowers using a 7A Loan can acquire up to $5 million to cover most of the purchase of the business. However, there are certain “minimum” qualifications you must meet. Additionally, the lending institution has the freedom to add to these qualifications as well.
Seller financing is essentially an agreement between you and the seller that you will make payments to the seller over a certain period of time for the purchase price of the business plus interest. This avenue can be a far more beneficial way to finance an acquisition for several reasons. First, it is much easier to obtain than conventional financing from a regulated financial institution. Second, it gives the seller a vested interest in disclosing accurate performance information.
It is important to keep in mind that seller financing will only be provided after the seller does their due diligence on you. Typically, they will want to see your experience, a business plan, assets, and your credit.
One of the downsides to Seller financing is that most if not all sellers are willing to finance only 30-60% of the purchase price. So, unless you can prove that you are a strong buyer with a sizable amount of collateral it may be difficult to negotiate a seller financing deal.
Seller Financing/Traditional Loan
In some instances buyers are able to obtain financing through a blend of a traditional loan and Seller financing. From the buyers perspective this avenue can be advantageous for two reasons. First, it maintains that vested interest for the seller to be open about the companies overall well-being. Second, it could potentially be much easier to obtain traditional financing. For example, instead of going to the bank and asking them to finance 70-80% of the acquisition. You may now be able to request the seller finances 20% of the deal (leaving you with 80%). Considering you were able to put down 20% of the original amount, you can then go to the bank and request 60% of the original value of the business.
A Leverage Buyout or LBO is when a buyer uses the assets of the acquiring company (along with some of there existing assets if need be) as collateral on the loan. The upside of structuring a deal this way is that it limits the amount of up-front cash required to invest, thus maximizing your returns. The downside of an LBO is that it can also maximize your losses if you are unable to repay the loan in a timely manner. Also, interest rates on LBO’s tend to be much higher than other financing resources.
In today’s day-and-age there are a significant amount of ways one can finance an acquisition. That said, it is important to keep in mind your long-term goals for this investment. Some funding sources may seem more enticing than others because they may allow you to simply acquire the funds required to start this venture. However, that does not necessarily mean it is the right funding source for you. Therefore, before you make any decisions on how you would like to fund the acquisition of a business be sure to contact someone with experience in this realm and allow them to assist you in finding the right funding source for you.