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Thursday, April 23, 2009

How to Finance Buying a Business

Peter King
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In this day and age, more people that have found themselves out of work are going into entrepreneurship, specifically buying an already existing business. What you may not know is that obtaining the necessary funds is easier than you think; you just need to be aware of the options that you have available.  
Stay Clear of the Bank
In most cases, you won’t be able to find funding from traditional lenders such as banks. They are not business or client friendly, no matter how much they may advertise otherwise.  
The decision on their end has nothing to do with the amount of experience that you may have or your current relationship with them. Unless you’re willing to collateralize the loan 100% with non-business and personal liquid assets, you will never see one dollar from them. They will always issue unacceptable terms.  
Seller Financing the Norm
Most acquisitions of small businesses involve seller financing today. Probably over 80% of all deals include some form of financial aid from the previous owner, where the seller will put down 30-40% of the total purchase price. By providing backing, the seller validates the viability of the business itself; and is able to obtain the highest price possible by funding part of the acquisition.  
If you’re the buyer, you are reassured that the seller is also at risk in the transaction because of their agreeing to finance. It helps ensure that what you’ve been told by the seller is true and accurate. It also serves as a mechanism to deal with situations that may arise later on that come as a result of your actions where you may need the ability to offset their financing.  
Generally, as a buyer, you can expect to pay about 6-8% over four to five years. Seller financing also provides the freedom to be more creative with payment options than if you were even able to get backing from a bank. You can negotiate a holiday from any payments for three to six months after closing. You have the right to make lump sum payments several times a year toward the principal. You can also arrange for lower payments throughout the loan with a balloon payment down the road. Finally, while you will have to personally sign the loan agreement with the seller, you will not have to personally collateralize the loan. Your lien is against the assets of the business.  
Exploring the SBA Option
What the Small Business Administration (SBA) does is guarantee loans that are made up by lenders up to a certain amount for small business acquisitions. There are advantages and disadvantages to obtaining a SBA loan:  
  1. Currently, there’s up to $1.3 million plus additional funding available should it include real estate;
  2. You have favorable terms for repayment up to 10 years and higher when real estate is involved;
  3. You’ll know that the business your purchasing is solid in condition if it passes SBA qualifications;
  4. You may not have to fully collateralize the loan if you have at least 25% equity in your home;
  5. The loan will finance 70-80% of the deal.  
  1. Most small businesses won’t pass the SBA requirements;
  2. The financial review is based upon the weakest of the past three year’s tax return;
  3. You have to have demonstrative experience in the industry that’s similar to the one that you are considering;
  4. You will have use your home, life insurance policy (possibly) and your first-born as collateral;
  5. To complete the entire process can take up to 90 days.  
With everything being said, you should explore the option of obtaining a SBA loan. You’ll want to approach a bank that’s a “preferred SBA lender” – most of whom have this status. This allows for the banks to approve the loan on their own without having to submit everything to the SBA. If you choose this route, make sure that you are precise in asking the lender for timelines to complete the transaction.  
Best Financing Route to Take  
Overall, 90% of all transactions involve some financing. Only 10% are actual all cash deals. Even if you’re willing to pay all cash for a business that’s priced for under $100,000 or receiving a major price reduction of at least 20%, we wouldn’t advise that route.  
Obtaining a SBA-approved loan does have strict guidelines that will help to confirm the viability of a business; however, we would only recommend this if you’re buying a business where you cannot finance the down payment.  
Out of all the options, seller financing is the most popular for obvious reasons – the flexibility. Most of you’ll be able to obtain favorable terms, and it forces the seller to share in the risk; something that you won’t find with anywhere else.


Response to: How to Finance Buying a Business
Matt Conway says
If you are buying an existing business with a history of revenue, it is a much easier proposition for a bank to lend you the money. My friend bought a franchise, and was able to obtain more financing than he thought because there were proven records of success.

Response to: How to Finance Buying a Business
Louis Rodner says
If you are also buying a property-based business, such as a hotel, then the loan can be leveraged against the value of the property. This means that even if your business fails, a bank can get its money back from the property.

Response to: How to Finance Buying a Business
Henry Armstrong says
Also keep in mind that your suppliers and vendors can be sources of financing for when you buy a business. Say you need an illuminated sign for your store front. The company that you contract with to make the sign may provide financing so you can make monthly payments rather than pay cash.

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