A detailed approach - How to fund the purchase of a business

One of the most important aspects to the purchase of a business is how it’s funded. Have cash? It might not be the best approach, as you could potentially leverage that cash elsewhere to earn more. The SBA sometimes lends up to 90% LTV, and depending on interest rates, it could be the most attractive option. Some sellers are willing to “play the bank” and offer seller financing. Here, a seller would require a healthy down payment and essentially lend you the remainder to be paid back upon an agreed schedule. These type transactions avoid lengthy and intrusive bank requests, but often gives you less leverage on your money.

Let’s look at a detailed list of ways to fund the purchase of a business.

All cash

While it sounds great, often, all cash isn’t the way to go. Most business buyers with a million dollars in cash look to leverage that money. Instead, they may look for businesses that require $800k down on a $4 million dollar business. Many business buyers think they can leverage their money to get a higher return elsewhere. Because of this, all cash offers are rare. Occasionally, larger businesses acquiring smaller businesses, private equity groups, and other institutional investors may buy businesses all cash, depending on certain circumstances. Often, like in real estate, all cash offers come at a discount to the price of the business. Instead of offering full price, all cash offers frequently come in lower. These buyers know that all cash offers carry a lot of weight. They try and get a quick discount this way.

SBA loan

One of the most common ways to buy a business is with an SBA loan. Not all SBA loans are created equal. If the bank doesn’t have an appetite for the industry, the rate or terms might be much different than a bank that enjoys lending into that industry. It’s important to note, the SBA doesn’t lend money. The SBA puts a guarantee on the loans that banks lend. The bank is lending the money, the SBA is guaranteeing it, up to a certain amount. These loans are subject to certain requirements to receive the guarantee. Some banks are preferred lenders with the SBA. This means they can approve and underwrite loans in-house vs sending them to the SBA for approval (which takes more time). Each SBA loan will require an equity injection. This is any amount, but almost always about 10-15% of the loan amount. A buyer can always put “more down.” For the equity injection to receive an SBA loan, buyers either use cash, savings, stocks, bonds, 401k/retirement, or even home equity loans. The SBA has loans specific for business or business +real estate.

Seller financing

One of the other most common ways to buy a business is with seller financing. A buyer can put down a sizeable down payment, often 20-50% of the total purchase price, and have the seller “lend” the buyer the remainder. This remainder is subject to an interest rate, payback period, security agreement, promissory note, and often a personal guarantee. Pros of seller financing include not having a bank involved. Banks are very intrusive and will require many things to finalize the loan. With seller financing, the seller plays the part of the bank. If the buyer seems like a good credit risk, the seller can have the sole approval in moving forward. The cons of seller financing include the de-leveraging of your cash down. If you’re putting $300k down for a business priced at $900k, you could often get an SBA loan and acquire an even bigger business (through higher leverage). Occasionally, sellers are willing to take little money down with seller financing as the remainder. These are a buyer’s ideal target.

Conventional loan

If a buyer went to their local bank and asked for a loan to buy a business, the banker would likely point towards a conventional loan. These loans often require 30-50% equity and have hard costs associated with them, to be paid upfront, whereas, an SBA loan allows a borrower to roll those fees into the loan. A conventional loan could also have prepayment penalties, along with balloon payments or adjustable rates. SBA loans are more predictable with fixed rates or a set duration of ten years. Some borrowers have been rejected for a conventional loan, yet been approved for an SBA loan on the same business.

401k or retirement accounts

You may want to consider utilizing your 401k or retirement plan to fund your business purchase. CBA has referral relationships with leading firms that facilitate this process. Some business buyers chose this option to avoid more debt. If done correctly, these programs have no early distribution taxes or penalties. They also wouldn’t be subject to interest, such as an SBA or conventional loan.

Creative financing or private lenders

The state or federal government have special programs set up for a variety of demographics. There are advantages to these programs, as they often are fast-tracked through the approval process, and sometimes receive favorable rates. One example is a federal program through the SBA for veterans. Please visit the SBA’s website, as they best outline each program. Another funding source to acquire a business is the private lending market. One example here is hard-money-lenders. Since private lending is such a small part of our marketplace, we encourage you to research private lenders on your own.

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