The thought of owning your own business can be thrilling, but it can also feel overwhelming at the start. The first step is to decide whether you’ll create your own company or purchase an existing business instead. Regardless of what you decide, a key step in the process is determining how to pay for it. This article provides a detailed review of the main business acquisition financing options.
You don’t have to start at square one to become a business owner. Buying an existing business provides a fast-track option to becoming your own boss while sidestepping some of the challenges and risks of a startup.
The catch is that buying a business usually requires much more capital. If you don’t have the savings to cover the cost, you’ll need to apply for a business loan. To qualify, you will need to determine your needs and requirements, prepare the right information and documents, and shop for the right lender.
7 steps to financing the purchase of an existing business
- Review the benefits of buying an established business to see if they match your goals
- Calculate how much money you’ll need to obtain the existing business
- Gather professionals on your acquisition team, such as lawyers and accountants
- Gather the necessary documents and financial information
- Find out if you qualify for a loan
- Choose the best financing option
- Apply for a loan to buy the business or set up crowdfunding if that is the best route
Best financing options for purchasing an existing business
Various business financing options exist for funding the purchase of a business. Which type of business loan you choose will depend on the financial health of the business and your personal financial situation.
Online loan lenders
A variety of online lenders offer the opportunity to quickly fund your business acquisition and may be able to finance business acquisition loans that have better terms than you’d be able to secure through a traditional lender or bank. These lenders lack physical bank branches and conduct all of their business over the internet. They’re also distinct from their brick-and-mortar bank counterparts because they tend to specialize. Such lenders provide loans up to an average of $500,000 and lines of credit that allow you to buy a business.
The APR (annual percentage rate) on online lender loans varies widely, depending on the size of the loan, your credit rating, the repayment term, and whether you’re providing collateral. APRs for online loans tend to range from 6% to 25%, or even higher.
Approval is more likely with online lenders, and you’ll often get funding very quickly. In some instances, you’ll have the money to buy a business in as little as 24 hours.
Traditional bank loans
Banks offer business loans that allow you to buy an existing business, including term loans, commercial mortgages, and business lines of credit. They often offer competitive interest rates. The average interest rate on a conventional small business loan is around 3% to 7%. That said, interest rates will vary across lenders, with banks typically offering lower interest rates than alternative or online lenders.
Bank business loans typically take a minimum of two months to process, which often makes this option unrealistic for some business acquisitions that happen quickly. If you have to wait too long, you may risk losing the opportunity to buy the business.
You may also have a hard time qualifying for a traditional bank loan if the business isn’t showing a high enough sales volume on your income statement, you don’t have sufficient cash reserves on your balance sheet, and/or your personal credit history is lacking (i.e., your credit score isn’t excellent – 700+).
Documents and information you typically need when applying for a business loan.
- Business documentation such as filing documents, organizing documents, articles of incorporation, and/or certificate of resolution
- Business name, address, and tax ID
- State in which the business operates and was formed
- Date the business was established
- The Social Security number, address, and date of birth of all business owners
These details will be used to review your credit history and guide the lender in deciding what financing options will be available to you to buy a business.
Small Business Administration (SBA) loans
The Small Business Administration (SBA) offers various small business financing programs through banks or preferred lenders. SBA loans are a good option if you have trouble qualifying for a traditional bank business loan.
SBA Loan types
- Standard 7(a) loans
- SBA 7(a) loans
- SBA Express loans
- Export Express loans
- Export Working Capital Loan
- International Trade Loan
How to choose the best SBA loan option
SBA 7(a) loans, a program that offers up to $5 million, may be a good option when real estate is part of a business acquisition. They can also be used for short and long-term working capital, refinancing current business debt or purchasing furniture, fixtures, and supplies for the business.
If you’re in a hurry to get a loan, your business acquisition purchase may qualify for the SBA Express Loan, which lends up to $350,000. The SBA Express Loan is for any small business (as defined by the SBA) operating for profit within the USA. The potential buyer should have already looked for other funding options before seeking financial help through the SBA loan program and must not have any existing delinquencies or debt obligations to the U.S. Government. SBA-approved lenders will assess the nature of the existing business by reviewing aspects of your business plan. They will also run several checks during the application process. If you’re approved for an SBA loan, you’ll receive your funds within 90 days.
And if you’re a veteran, you can qualify for the SBA Veterans Advantage, which offers either $350,000, if processed under the SBA Express, or up to $5 million, if processed under the SBA (7) a loans program. To encourage lending to veteran-owned small businesses, the SBA is providing a reduction in certain loan program fees through this program.
In order to qualify, businesses must be 51% or more owned and controlled by a member of the military, national guard, or individual(s) with veteran status as defined by the SBA. During the SBA loan application process, lenders must document in their loan file a borrower’s eligibility using certain documents such as a DD-214 and DD Form2.
Finally, some small business owners are using crowdfunding or peer-to-peer (P2P) financing to buy a business. Often, crowdfunding campaigns are for mission-driven, community-minded, or innovative product or service ideas because that is what motivates people to give to the project.
Instead of a loan that needs to be repaid, crowdfunding generally involves a reward for monetary contributions, like an early edition of the product or more exclusive offers for larger financial contributors. One advantage to this kind of financing is that it often comes with customers ready to purchase a product or service. Those that are motivated to contribute to a fund are much more likely to seek out that same business for products or services in the future.
The disadvantage can be that there is risk involved. Small business owners may struggle to get their product or service up and running even after a crowdfunding campaign, which makes fulfilling the campaign “rewards” challenging. Business owners who have used this method of financing in the past say that it’s not for everyone but can be a good way to test market value to see if the product or service you’re offering resonates with your intended customer base.
In some cases, the seller may be willing to finance the purchase or act as a lender for the potential buyer. This is known as seller financing. The seller of a business helps a new owner finance the purchase of the business, and later the seller is slowly paid back over the course of the loan repayment term. By providing seller financing, the seller can help find a buyer for their business more easily and keep some funds from the business coming to them even after they’ve sold it.
Seller financing is usually offered at a competitive interest rate, and it helps ensure that a seller is completely honest about the financial standing of the business. After all, their loan won’t be repaid if the business isn’t set up for financial success.
Sometimes the seller will ask the buyer to put up collateral in case the buyer defaults on payments. The simple definition of collateral is that it is a tangible or intangible asset that a borrower (buyer) pledges to a lender (seller in this case) to secure a loan. If a borrower defaults in their obligations or cannot pay their loan payments as agreed, the lender can take action to foreclose on the collateral (or take it) and try to sell it to recover the loan amount. Collateral always helps lessen the risk for a small business owner who is willing to provide seller financing for a buyer.
Consider the benefits of business acquisition
Successfully buying a business is an exciting adventure, and there are unique benefits to buying an established business as opposed to starting new.
First, business acquisition can be seen as less risky financially than financing a new venture. This fact makes it more likely you’ll be able to find financing through a bank or lender. When you buy an existing business, you inherit a customer base, company reputation, and employees that may offer new talents and skills. You also take over the company’s cash flow and profits. If the existing business has been successful in the past, the business has already proved itself, meaning that small-business lenders will be more likely to give you a loan to purchase it.
Potential Tax Benefits
Second, there may be tax benefits to purchasing an existing business if you plan to combine it with a current one that you already own. When combining two firms, if one is subject to a lower tax rate, the acquisition might minimize taxes for the combined firm.
Already Market Tested
Third, the product or service that generates revenue is already market-tested, which will significantly reduce your risk and start-up time. Rather than trying different versions of a product or tweaking your services to meet the demands of new customers, you can learn from past events that may be a predictor for future success.
If the benefits of business acquisition seem to outweigh the risks, follow these steps to finance an acquisition, and you’ll soon be calling yourself a business owner!
How to apply for business acquisition financing
Calculate Your Need
Before applying for financing, calculate the value of the existing business and how much money you’ll actually need, advises Jonathan Aspatore, the CEO and founder of The ExecRanks. He is a business owner who founded two prior businesses, which he later sold to Fortune 500 companies.
“Plan for 20% more costs than you imagined, both for the eventual purchase price and for professional services bills, such as from lawyers and accountants”
Give yourself some wriggle room
“Plan for 20% more costs than you imagined, both for the eventual purchase price and for professional services bills, such as from lawyers and accountants,” he says. Leaving wiggle room in these areas helps ensure you borrow as much money through business financing as you require. Being thoughtful as you determine the loan amount will help you avoid surprises down the road.
Lawyers and accountants are worth this extra cost and can be valuable members of your business acquisition team. They can help you determine the value of the business and answer questions that might arise as you create your business plan. Such professionals will review business tax returns and financial statements and verify information about the business you want to acquire. This may include things like how profitable the business is, the existing inventory level, and an analysis of receivables. All of this information can assist you in determining whether the asking price is a fair one.
Gather the necessary documents
- Personal tax returns
- Personal bank statements
- Business bank statements provided to you by the business you’re acquiring
- Business tax returns provided by the business you’re acquiring
- Statement of cash flow, income statement, and balance sheet provided by the business you’re acquiring
- Business legal documents, including a franchise agreement (if applicable), articles of incorporation, and commercial lease paperwork
In addition, the lender may want to see a professional business evaluation, including a list of business assets and a letter of intent (an agreement between you and the seller to purchase the business, which often lists the purchase price).
Find out if you qualify for business acquisition financing
Before approving a loan for business acquisition, lenders will review several factors to determine if they want to extend credit to you as part of the loan application process. It is important that you also review these factors before applying for a loan to purchase an existing business.
Check your credit score
The higher your personal credit score, the more options you’ll have for business loan financing and the better your interest rate will be. If you already own a business, you should also check your business credit score by using business credit bureaus, such as Nav. A credit score of at least 680 makes it more likely you’ll be able to get funding to buy an existing business. There are also online loan providers, such as SmartBiz, which provide SBA loans for individuals with lower scores.
If possible, it is a good idea to improve your personal credit score before asking to get a loan. You can do this by first reviewing your credit report, disputing any errors, and paying any outstanding debts that you owe. If you already own a business, it’s critical to make sure its finances are in order, and all bills are paid as well.
After that step is complete, it may also help to understand where other business owners have found financing and why business loans often get denied. If you have a bad personal credit history, consider these tips for those without high credit scores.
Look at how long the company has been in business
The longer the existing business has been in operation, the better. For most online loans, the business needs to be operating for at least a year, and the requirements go up to two years for traditional bank loans. With a track record of success to reflect on, the bank or SBA lender will feel like you’re less of a risk.
Online lenders and banks require a minimum annual revenue, which is often in the $50,000 to $150,000 range. You can get an idea of where this stands for the business you are looking to acquire by reviewing their income statement.
Examine cash flow
Directly related to revenue is the business’s cash flow, which will determine if you have enough funds to keep the business operating while paying necessary bills, such as your loan payment. This takes doing a careful analysis of the financial records (specifically the statement of cash flows) of the business you want to buy, as well as your own finances. If you already own a business, be sure to consider the cash needs of that business and your personal need for funds as well.
Apply for a loan
Before you can start applying for loans, you’ll have to have some arrangements in place, such as a written agreement with the seller (current owner of the business) you intend to purchase. Once you’ve chosen the type of financing option you want, gather your necessary paperwork and fill out the required crowdfunding paperwork or loan application with your bank or lender (ex. SBA). For a loan, banks may require a review of your business plan and personal credit score, along with requesting copies of personal and business tax returns.
Loans can differ from one another when it comes to repayment term length, interest rates, collateral requirements, and other important features. Many times, online lenders make it easy to get preapproval offers so that you can compare various business acquisition loans and their terms.
Generally, online lenders will require you to complete a short online application, verify your basic information, and then conduct a “soft” pull of your credit. This is seen by the credit bureaus as an inquiry and doesn’t negatively impact your credit score. If you meet the lender’s requirements, they’ll respond with an initial offer, potentially within just a few minutes.
This streamlined, quick process makes it easy to apply for multiple loans and compare their preapproval offers before choosing the option that’s best for you. Check out SuperMoney’s Business loan comparison tools to read reviews and compare the rates of leading business loan providers.