When most people think of starting a business, they often think of starting from scratch. But starting from scratch has its own hurdles to overcome like the difficulty of building a customer base, marketing the new business, hiring employees, and establishing a cash flow. And business owners have to do all of that without a reputation or track record to go on.
On the flipside, when you buy a business, you take over an operation that’s already generating cash flow and profits. You have an established customer base and reputation as well as employees who are familiar with all aspects of that particular business. You don’t need to spend time and money setting up new systems or policies since a successful formula for running the business has already been put in place.
Experts say that it costs less to buy an existing business than to build one from the ground up. If you are an entrepreneur looking into purchasing a business, there are a few items to consider when seeking financing for the acquisition.
Get Your Business & Personal Finances in Order
When you apply for a business loan, your business finances aren’t the only thing you need to get in order. You might be surprised to learn that your personal finances are a deciding factor on being approved. From the lender’s point of view, they’re lending money to a small business owner, not just the business itself. So as the soon to be business owner, how you handle your personal finances is very important.
- Personal credit score: Lenders see your credit score as a significant factor in your likelihood of making your business acquisition work in order to make your loan repayments. A credit score of 575 or above means you have more loan options available to you. Anything lower than that, and you might difficulty being approved for a loan.
- Business credit score: Your business credit score and history are one of the many important factors in determining your eligibility for a business acquisition loan. Your business credit score is determined through five main factors: your payment history, amounts owed, your length of credit history, types of credit used, and your new credit. Payment history is the most significant of these factors, so it’s critical to always make debt payments on time, both personally and for your business.
- Personal tax statements: Your lender might ask to verify your personal income. Have your last two to three years of tax returns available when submitting your application—and if you haven’t yet filed tax returns for the current fiscal year, provide your extension paperwork to make it clear that you’re still in good standing with the IRS.
- Business Tax Statements: You should have the revenue of your existing business through your state and federal tax returns at the ready.
- Cash flow statement: The cash flow of your existing business acts as a snapshot of its financial health. It’s a good indication of whether your existing business can support the debt of a business acquisition. Positive cash flow is a sign that you’re managing your business finances well, and a strong profit margin gives you the necessary buffer to make payments on your acquisition alone, even if your newly acquired business isn’t immediately profitable.
- Outstanding debt: If your current business has any outstanding debts indicated on your balance sheet or other financial records, this can have a serious negative impact on your ability to qualify for a business acquisition loan. Typically, your current outstanding debts will take “first position,” meaning that in the event that your business could not repay all its debts, they would be the first ones to get repaid.
Types of Acquisition Loans
SBA 7a loan: Loans backed by the US Small Business Administration (SBA) are a popular source of financing for business acquisitions because of their low interest rates. SBA loans are great for small and large acquisitions as you can borrow up to $5 million. However, to qualify for this type of loan you need a credit score of 680 or above, a 20% down payment, and business management experience.
Seller financing: The vast majority of small business acquisitions involve seller financing. In fact, it’s estimated that over 80% include some form of seller financing. While the percentages vary, it’s generally 30% to 50% of the total purchase price. Seller financing is a flexible option, because terms are fully negotiable between buyer and seller. It can also be the fastest route to a closing.
Asset-based loans: These are revolving loans secured by the available collateral such as inventory, accounts receivable, equipment, and fixed assets. The amount that can be borrowed is typically between 65%-80% of the assets. An asset-based lender looks to collateral first, debt load, and quality of earnings. The main drawback of using this type of loan for financing is the expense. Pricing among lenders is competitive, but interest rates typically range from 12%-28%.
Start up loans: These loans are available through specific lenders who won’t expect revenue or credit history from an existing business when they evaluate your finances as the borrower. The lender will expect you to put some skin in the game, usually in the form of at least 20% of the purchase price as a down payment.
Which Loan is the Best?
Seller financing is the best financing option when buying an existing business. But don’t get me wrong, sellers still want a buyer who is experienced in the industry, with a solid business plan, working capital, and being part of the community doesn’t hurt either. And just because the terms of financing are flexible doesn’t mean that sellers aren’t any less serious than other lenders. They still require a credit check, collateral, and usually life insurance. Loan terms often extend up to 10 years and interest rates are comparable with those offered by banks. However, not having enough capital isn’t the only reason to ask for seller financing. These loans also can bridge the gap if you and the owner can’t agree on price. And they’re negotiable. Maybe you need lower interest rates, or your personal credit score isn’t that great. These are real people you’re dealing with so being upfront about your finances ahead of time can help build trust and get you the financing you need.