Buying an existing business can seem less daunting than starting a business from scratch. And in many ways, that’s true. But there’s still a lot you need to know — especially how to get a loan to buy a business..
Unless you’re already rolling in it, you’ll probably need to apply for financing. The amount you get with a business acquisition loan depends on the business you’re buying. Just like any loan, the rate you get depends on your qualifications.
There are some key things to note, and it’s important to pay close attention to what you’ll need to secure financing for a business acquisition.
Financing for a startup vs. an existing business
Financing always comes with challenges and headaches. The lender will scrutinize your taxes, credit score, available cash, debt burden, and the finances any other business you already own.
But unlike a loan for a business you own, you’ll also have to provide all that information about the business you intend to buy. You’ll need to make a case why a lender should give you the money to buy it. This can be a real challenge for many reasons, and while there is no loan made specifically for business acquisitions, some options are better than others.
What you’ll need to secure financing
When we look at how to get a loan to buy a business, it’s important to know lenders will scrutinize your personal information and documentation as well as the existing business’s. Expect them to take a close look at things like:
- Credit score
- Annual revenue
- Time in operation
- Tax returns
- Balance sheet
- Cash flow
- Outstanding debts
Other than that, you’ll need to make them believe in the future success of the business.
In addition to the traditional financing documentation for both you and the existing business, you’ll also have to:
Provide a formal business valuation. You’ll need this for both negotiating the price of the business sale as well as for financing the purchase. (More on this in a bit)
Demonstrate relevant experience. Have you run businesses before? Have you worked at a high level at a similar business? Make sure it’s relevant experience as opposed to abstract or emotional.
Offer an updated business plan. This document should demonstrate your financial projections for the business under your command.
How do you measure the existing business’s valuation?
It will help to consult a professional — a lawyer, banker, or accountant — to help, and it’s especially wise to hire an expert business appraiser who can provide answers when it comes to how to get a loan to buy a business. These are the basics:
- Evaluate financial statements. What are the company’s historical earnings and methods, including debt-paying ability and burden, cash flow, and earnings capitalization?
- Look to the future. What are the company’s prospects for future growth?
- Check the market. What’s the value of assets including real estate, machinery, inventory, and anything that would be transferred in a sale?
- Look at comps. What’s the market for similar businesses, and have there recently been similar sales of similar businesses?
How to get a loan to buy a business: Funding options
So, how are you going to fund this thing? Sit down unprepared with a lender, and you’ll likely be overwhelmed in short order by all the different types of financing, applicable in a broad array of situations. Let’s look at a few of the best options.
Traditional term loans
If you’re looking for a fixed interest rate and predictable monthly payments, a traditional term loan is just for you.
The terms are pretty simple — you borrow a fixed amount of money and pay back the loan over a fixed period of time, and typically at a fixed interest rate. Term loans are the most common type for business acquisition, since they fit with typical costs and the long-term nature of purchasing an existing business.
However, many lenders will have high standards for your business acquisition deal in order to fund your term loan, and you might not qualify on your first try. Prepare for one or several lengthy applications to secure a term loan for your business acquisition.
SBA 7(a) loans
“Loan” is sort of a misnomer here. The U.S. Small Business Administration is not a lender. Rather, think of them as your Government Guarantor.
Basically, with a 7(a) loan, the SBA “guarantees” all or part of certain loans, incentivizing lenders to approve more borrowers. This will increase the chance that you will get approved for funding by mitigating some of the risk for the lenders through the SBA.
The 7(a) loan allows small business owners to borrow up to $5 million in funds for working capital, equipment purchases, real estate purchases and basic startup costs.
Sounds like a no-brainer, right? The only reason you wouldn’t apply for this is if you already feel there’s a good chance of approval by a lender, and you don’t need the unnecessary headache of applying through the SBA first to increase your chances.
Keep in mind, there may be additional rules and complexities around acquiring a business with help from the SBA.
This is a good option if you’re a relatively new entrepreneur. Startup loans are like term loans, but they’re only available through specific lenders who won’t expect revenue or business credit history from you when they evaluate your finances as the borrower.
In other words, they’re more lenient. But that comes with some cost to you, the borrower. The lender will expect you to pay more upfront, usually in the form of at least 20 percent of the purchase price as a down payment. Interest rates on startup loans are also typically higher.
In some cases, the majority of the purchase price for the business you’re acquiring is based on the value of equipment or other assets transferred. If that’s the case, an asset-based or equipment loan could be a great source of financing for your business acquisition.
A small business equipment loan can be used for virtually any equipment need, from computers, to production machinery, to vehicles and more.
When it comes to asset-based loans, you’ll borrow capital against a certain asset, using it as collateral in case you default on your payments. The amount you can borrow depends on the type of asset, the price, and whether it’s new, used, and its relative life expectancy.
Asset-based financing can reduce the overall amount that you borrow. This decreases your debt burden, and makes qualifying much easier. However, it’s not a full purchase of a business, so if that’s what you’re looking for, you’ll need additional financing.
Avoid these common mistakes when you secure financing
It’s easy to get excited as you near the finish line. But keep your eye on the ball, because there’s a lot to consider beyond how to get a loan to buy a business. Stay smart by identifying and avoiding a few common pitfalls, and lay the foundation for success down the road.
High monthly payments
Don’t overestimate your repayment abilities. You can’t expect everything to go according to plan when it comes to running a business. Mistakes, mishaps and unexpected disasters are bound to happen. Negotiate your payment plan so the beginning payments are fairly light, giving you the space to mess up when you’re new at running the business.
Unverified statements and quotes
The more you want the business, the easier it can be for your seller to take advantage of you. In other words, do your due diligence: make sure all the financial statements are accurate and that the equipment quotes you’re given are fair.
Check the books yourself, or give them to your banker or accountant, to make sure everything is as you were told.
The process of securing financing to buy an existing business can be challenging, but it’s certainly possible. Just be thorough and consider all available options. If anything, it’ll make great practice for running the business you intend to buy!
The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.