Buying a business is a big undertaking. Getting a loan to buy a business can seem just as tough. Banks set high standards that both you, and the business you’re buying, have to meet before being approved. We’ll show you how to get a loan to buy a business and where to find business acquisition financing.
Most people haven’t heard of a ROBS, but it may help you fund your business acquisition. A ROBS lets you use retirement funds without paying early withdrawal penalties or taxes to buy a business. If you have $50k+ in retirement savings, schedule a free consultation with an expert at Guidant to discuss your options.
Getting a Loan to Buy a Business
There are five primary financing options to buy a business, starting with SBA loans and ROBS as the two best business acquisition financing options. The table below gives a brief summary of all five options.
Business Acquisition Financing Options
|SBA Loans||Prime borrowers looking for the longest repayment terms and lowest interest rates.|
|Rollover for Business Startups (ROBS)||If you have $50K+ in a retirement account you can use it to buy a business, or as a down payment for an SBA loan.|
|Seller Financing||The seller can finance part or all of your purchase. This works well with other financing sources, like ROBS or SBA loans.|
|HELOC & HEL||When you have 20%+ equity in your home, and are okay using your personal home as collateral for your business.|
|Family & Friends Loan||If you have wealthy friends or family members who believe in your business and want to invest.|
Here are the five most common loans to buy a business:
1. SBA Loans for Buying a Business
If you’ll be needing a loan to purchase a business, we recommend that you begin your search for financing with SBA loans.
SBA loans are generally the least expensive sources of capital available to a small business owner. Additionally, it’s typically easier to get approved for SBA financing to buy an existing business compared to getting approved to fund a startup. This is because the lender is able to better judge the existing business’s potential to repay a loan by looking at its track record rather than pinning their hopes on a startup’s projections alone.
Most lenders will first consider you for an SBA loan because these loans are partially guaranteed by the U.S. Small Business Administration. SBA loans have the most competitive interest rates and longest repayment terms of just about any financing option available. The downside of working with an SBA lender is that it can be difficult to qualify, and even if you do, it can take a long time to get financing (45-120+ days).
SBA Loan Terms & Qualifications
An SBA loan will typically carry similar terms and qualifications to a traditional bank loan. The lender is generally looking for prime borrowers with a strong business plan, and may require some collateral to get approved. The process is generally longer than other financing options, taking anywhere from 45-120+ days.
What you’re buying also weighs heavily in what type of SBA loan you get. For example, if you’re buying commercial real estate, you may benefit from getting an SBA 504 loan instead of a more traditional SBA 7a loan. The SBA 7a loan is the one we’ll discuss in this article.
Terms and Cost of an SBA Loan to Buy a Business
Here is a look at the typical rates, fees, and repayment terms of an SBA loan to buy a business:
- Loan Amounts: Up to $5 million
- Interest Rates: SBA loan rates vary based on what the current U.S. prime rate is. They are typically around 6-9%, but you can check out our article on the current SBA loan rates.
- Fees: SBA loans have a guarantee fee starting at 3% of the loan amount for loans over $150K. There may also be fees associated with a loan, such as application fees, third-party closing costs, or prepayment fees.
- Repayment Schedule: The term of an SBA loan will vary depending on the type of business and what is being purchased. The standard term for SBA loans is 10 years for working capital and 25 years for real estate. Keep in mind, a longer term means lower monthly payments and better cash flow, but it also means that you are paying interest for a longer period of time, which could increase your total cost of capital.
How to Qualify for an SBA Loan to Buy a Business
To get an SBA loan for a business acquisition, you typically need to meet five criteria:
- Credit Score above 680 (check your credit score for free)
- Down Payment of 10-30%
- Sufficient Collateral (business and/or personal assets, real estate preferred)
- Industry Experience (over 3-5 years preferred, but you could also have someone to run the business with industry experience that is not you)
- Buying a Financially Strong Business (making money)
If you can put a check next to each of the criteria above, your chances of qualifying for a loan are good. If you’re not that strong on one or two of these criteria, that doesn’t mean that you can’t get a loan, but it will be much more difficult. If that’s the case, then you should be prepared to talk through those weaknesses in your application with your loan provider.
Here’s the 5 qualifications for an SBA loan to buy a business in more detail:
1. Personal Credit Score
If your credit score is beneath 680, obtaining an SBA loan will be very difficult (Check your credit score for free here). If your score is below 680 and you want to speak with someone about how you can improve it, read our complete guide to the best credit repair companies.
A credit score is a number that lenders use to quickly determine how creditworthy an individual is. The number is based any many pieces of data, including your credit history, your current debt-to-credit ratio and debt-to-income ratio, and their experience with people who had histories similar to yours. Essentially, this number describes how likely you are to repay a loan.
2. Down Payment
You should be prepared to put some of your own cash toward the purchase of the business. Without some skin in the game, a lender is unlikely to give you an SBA loan.
Every deal is different most banks expect at least 10-20% down from the borrower and, depending on the deal, may require as much as 30% down.
If you have a superb credit score and/or a lot of valuable collateral to offer, you may be able to get away with only 10% down. But if your credit score isn’t great, if you lack significant collateral, or if your industry experience is limited, expect to need between 20-30%.
Lenders prefer down payments that come from cash savings. They prefer the funds being used for the down payment are not the result of new or additional debt (except in rare circumstances where that debt has very favorable terms).
If you don’t have cash saving available to you, there are four alternative sources for the required down payment:
ROBS (Rollover for Business Startup)
One popular way of coming up with a down payment is to use money you’ve saved in a retirement account, and a ROBS let’s you do it without paying taxes or withdrawal penalties. We advise using a ROBS only if you have at least $50,000 in your retirement account that you plan to use. In addition, it’s best to use a professional ROBS provider to assist you with this process as the tax and legal issues involved are very particular.
Cash Out Your IRA or 401k
Another retirement account option is to cash out your retirement accounts. We don’t recommend this option due to the heavy taxes and penalties you’ll have to pay, but it could get you access to the funds you need for a down payment on an SBA loan.
If you’re in the lowest tax bracket then you may not be hit very hard, but you’ll have to pay gross income taxes at the federal and state levels, and pay a 10% penalty on top of it. You can learn more about how to buy a business with your 401k or IRA by reading our article.
Home Equity Loans and Home Equity Lines of Credit
If you’re a homeowner, you can use a home equity loan (HEL) or a home equity line of credit (HELOC) to come up with a down payment. After all, many HELs AND HELOCs can have great interest rates and generous terms.On the other hand, by utilizing a HELOC or HEL you reduce the equity available in the property being used as collateral for your business loan.
While not strictly considered part of your down payment, seller financing can boost your deal’s total equity injection. Keep in mind, when seller financing is used alongside SBA financing, the seller must be willing to take a standby position for 2 years and subordinate to the SBA lender.
This means the seller won’t receive payments on the loan for 2 years (or will receive interest-only payments), and if the loan defaults, the SBA lender gets first dibs on proceeds from the sale of assets or collateral.
Even if the business you’re looking to buy is highly profitable, an SBA lender will still expect you to put up some collateral for the loan. The reason is that, no matter how well a business has historically performed, there is always a chance that it can fail. Sufficient collateral provides security in case the business fails and you can’t pay back the loan.
Real estate, whether business or personal, is the most attractive form of collateral because it is most likely to retain its value. Other than that, you may also be able to pledge equipment, vehicles, accounts receivable, and other business or personal assets as collateral.
Lenders typically discount the value of the collateral you pledge because the collateral can lose value over time and to cover the costs associated with liquidating the collateral. So for example, if you have real estate worth $250,000, the bank might discount its value to 80%, giving you $200,000 of collateral for your loan. Collateral such as vehicles, equipment, and furniture & fixtures are discounted even more.
Remember, even if you don’t pledge an asset as collateral, it may be covered by a personal guarantee. SBA loans are personally guaranteed, which gives the lender the right to repossess personal assets if you can’t pay back the loan. State laws protect certain possessions in collection efforts.
4. Industry Experience
Lenders need to feel confident that you’ll be able to repay the loan they give you. That’s why credit scores, down payments, and collateral are so important. The other piece of the puzzle is industry experience. Lenders need to feel confident that you have the ability to run the business profitably yourself or identify and hire a management team to do it for you.
Lenders will expect you to have 3-5 of direct industry experience at a managerial level or higher. Less than that will raise serious questions which will need to be allayed if you are going to get the financing you need.
If you don’t have much experience, one way to address that is with a solid 3 to 5-year business plan, complete with financial projections.
While many business owners are great at sketching out a back of the envelope business plan sufficient to convince themselves of an opportunity, this business plan must convince the bankers. That’s as demanding and skeptical a crowd as there is. Luckily, there’s easy to use business planning software out there that makes sure you cover all your bases and end up with a great looking business plan. We recommend LivePlan software.
5. Financially Strong Business
The business you’re trying to buy should have a strong financial track record. Most lenders are more inclined to lend money to someone buying an existing business than someone launching their own startup. This is because the existing business has a financial track record, which makes assessing the likelihood the business will be able to repay the loan much easier.
Lenders prefer the business to have been operating for 2-5 years and will want financials to show that the business is profitable and your revenues are stable or growing. If the business is not profitable or has declining revenues, the lender will be very skeptical that the business will be able to repay the loan. It will take a great deal of convincing (by way of strength in the other four categories we discussed) to get approval for the loan.
For example, you may qualify if you can pledge additional collateral or show another source of income that’s sufficient to cover the cost of the loan (and all other obligations).
If the business you’re looking to buy is profitable, you have a 20% cash down payment and a credit score above 580 (check here for free) you may qualify for an SBA 7a loan for business acquisition. Set up a free consultation with our preferred business acquisition loan provider, South End Capital. They offer long-term SBA 7(a) loans of up to $5,000,000.
SBA Loan Application and Documents
When applying for a business acquisition loan, you will be asked to submit financial and other documents for the business. Here are the main documents you’ll need to submit:
The purchase agreement is the document that states:
- Final purchase price of the business
- What is being bought (stock or asset sale)
- What is required by the seller and buyer at closing
- Effective date that ownership of the business is transferred
- If seller will help with transition (and terms)
- Responsibility for existing liabilities
The lender needs the purchase agreement to verify the business’ purchase price and learn more details about the business and whether some of what is being purchased may be considered collateral.
Before the purchase agreement, there may also be a Letter of Interest (LOI). This is less formal than the purchase agreement and sets out the preliminary framework for the business acquisition. Many lenders use this document to get their preliminary underwriting started.
Financial Documents for the Business
There are a variety of financial documents for the business that the lender will need to evaluate its financial condition. You should already have these in your possession from the due diligence process:
- Last 3 years business tax returns
- Year to date profit and loss, balance sheets, and cash flow statements
- Information on outstanding business debts
- Information on any long term contracts
- Complete list of business assets (including year, make, model, mileage/hours)
- Rent rolls if the business has tenants
- Business lease
- Organizational documents for the business (e.g. incorporation docs and business licenses)
- Business Plan
To learn more, read our article on how to apply for an SBA loan.
While an SBA loan may be what the majority of borrowers are looking for to buy a business because of it’s low interest rates and long repayment terms, there are other options. Let’s now look at the next four best financing options to buy a business.
2. Rollover for Business Startups (ROBS)
In most cases, buying a business is time sensitive. If your acquisition is delayed, the seller may simply decide to go with another buyer, and you’ll lose out on the opportunity. This is why so many people who could qualify for a bank loan to buy a business (if they wanted to take the time and jump through all the hoops) choose not to.
If they have sufficient money saved in a retirement account, they opt for a ROBS instead. If you have at least $50K in a 401(k), IRA, 403(b), or other eligible retirement account, a ROBS may be a good option for you.
A ROBS makes your retirement savings available for the purchase of a business without incurring the taxes and penalties that come with an early withdrawal. Plus, the funds are generally available in 2 – 3 weeks. That’s more than 4x as fast as a typical bank loan.
Our recommended firm for ROBS is Guidant. They have helped over 11,000 businesses invest over $3 billion in starting or buying a business.
3. Seller Financing
Seller financing is when the owner you’re buying your business from agrees to finance part or all of the purchase price. This can help borrowers with a less than prime credit profile gain access to an amount of affordable financing they may be unable to get otherwise. It also can speed up the sales process, and help give you an even larger amount of confidence in the business since the current owner is willing to have something invested in your success.
Typically, sellers open to offering seller financing will finance around 15-60% of the purchase price of the business they’re selling. The rates on seller financing are usually similar to prevailing market rates (an APR of 6-10%). These details will vary from deal to deal and are part of early negotiations, which should begin early in the sales process.
There are no specific qualifications for seller financing, because each seller will have different requirements. Many sellers will check your credit, and will want to see a respectable credit score, but you don’t have to be a prime borrower. If your score is 600+ then you’ll be acceptable to many sellers offering financing (check your score for free). You can learn more by reading our guide to seller financing.
4. Home Equity Line of Credit (HELOC or HEL)
A home equity line of credit (HELOC) and home equity loans (HEL) might be a good option if you’re willing to put your personal home at risk for the business you’re buying. According to a study by the NFIB, a small business activist, around 25% of small business owners have used a home equity line to at least partially fund their business.
To use a HELOC or HEL you’ll need a minimum of 20-30% equity in your home, and a 620+ credit score. These loans can be less expensive than even traditional bank or SBA loans, and the only collateral used is the home you’re using to borrow against. This is a very flexible form of financing where you can use the funds for anything you want, including buying a business.
You can learn more about whether or not a HELOC or HEL is right for you to buy a business by reading our HELOC/HEL guide.
5. Buy a Business With Friends & Family Financing
Borrowing from friends and family is very common for new businesses. In fact, according to National Venture Capital Association, around 24% of all startups get financing from either family members or close friends.
Buying a business that is currently in operation will likely cost more than you can raise from the people you’re closest to, but it could be an excellent resource to get a piece of the capital stack you need.
If you’re going to borrow money from friends and family, we recommend that you make it an official business transaction. The transaction should be in writing, and you should make payments on the money you borrow like you would with any other loan.
Pros & Cons of Loan Options to Buy a Business
|Low interest rates and long repayment terms |
Down payment as low as 10%
|Guarantee fee is charged
More paperwork and slower application process
Harder to qualify for than other financing
|No debt or interest cost because the money is yours|
No taxes or penalties for early withdrawal
Can be used as a down payment or combined with other financing
Setting up a ROBS is fast
|Setup fee and ongoing fees are charged
Risking your nest egg
|Seller has continued stake in business success|
Low interest rate
Can negotiate terms with seller
|Not available for all deals
Usually only covers a portion of the purchase price, so must be combined with other financing
|HELOC / HEL|
|Lower interest rates than most other forms of financing|
Flexibility in use of funds
|Reduces equity in your home and uses it as collateral|
|Friends & Family Loan|
Often inexpensive (low rates, flexible lender)
|Can create tension if business fails
Only available if you have wealthy friends/family
Business Acquisition Loan Timeline
When buying a business there is generally a timeline that you can expect to move through before you get to closing. It’s important that you make sure your financing timeline fits into the overall business closing process, and that you have the right documents prepared at the right time.
Here’s a typical small business acquisition timeline and process:
Initial Inquiry – (Time: 1 Week)
To learn about the business opportunity you’ll typically sign an NDA and receive some basic information. Business brokers typically like to receive an indication of interest in buying the business within 1 week of you receiving any preliminary data.
Data Request – (Time: 2-3 Weeks)
If you have a high level of interest in buying the business then you’ll typically request additional information to help you make a decision. The business will decide what information they’re willing to share, and will get you the data you request. You should start preparing necessary documents to get an approval from your lender, and reach out to potential lenders if you’re interested in moving forward with the business acquisition.
Letter of Intent (LOI) – (Time: 1-2 Weeks)
At this stage, if you want to move forward with the business then you’ll submit a non-binding letter of intent with what you anticipate offering for the business. If accepted, then this is when the business will want to know how you plan on paying for the funds. You should get a pre-approval from your financing company at this point. This is where the initial negotiations are done on things like purchase price and seller financing.
Full Company Review – (Time: 1-2 Months)
Once the LOI has been accepted then you’ll be able to review all of the information on the company. You will be able to request any data you want, and the seller will need to provide it to move forward. This is where you get to decide for sure if you’re going to move forward with buying the business. You should also be setting up your financing during this period by working with your lender and submitting all necessary documentation.
Purchase Agreement & Closing – Time: (A Few Days – A Few Weeks)
This is where a purchase agreement is negotiated, signed, and closing takes place. At this point your financing should be ready to fund so that you can make closing and not lose the business to an impatient seller.
Frequently Asked Questions
What Types of Business Acquisitions Do Banks Prefer?
Banks like certain types of business acquisitions more than others. That’s because, over time, certain businesses and industries have performed better and more consistently than others. They like safe businesses where the buyer has a lot of industry experience. Some of these businesses are:
- Professional Services (Accountants, Lawyers, etc..)
- Medical Services (Doctor, Dentist, etc..)
- Partner Buyouts
What Types of Business Acquisitions Do Banks Not Like?
Banks don’t like risky businesses or businesses with small margins. Some of these examples include:
- Vice industries
- Grocery Stores
- Hard to explain product based businesses
- Businesses who rely heavily on a single customer
How do I Also Buy a Business’s Real Estate?
Most people who buy a business purchase the assets and revenue stream of the business and pay rent to occupy the building or office from which the business is run. Sometimes, however, there’s an opportunity to also buy the property the business operates out of.
Buying commercial real estate with a business does two things right away: it will increase the business assets and collateral but also increase the asking price. If your acquisition includes the purchase of real estate, then you can consider an SBA 504/CDC loan for that portion of the purchase. 504 loans are typically the cheapest option to finance real estate purchases.
What if I Already Own Another Business?
Lenders refer to other businesses in your name as “associated businesses.” If you have an associated business in which you have a 20% or greater stake, the lender will want to examine the financial health of that business as well.
The lender must make sure that an associated business doesn’t pose a significant risk to your finances and your ability to pay on the loan you’re requesting for the new acquisition.
How Do I Find the Right Business to Buy?
Often times, business brokers will be experts in both the buying and selling of a business. Their expertise can be invaluable when it comes to understanding the market, the available inventory, expected price ranges, typical seller financing offered, and much more.
By providing them with an idea of what you’re looking for, your price range, and your timeline, you may save yourself a great deal of effort and time. You can also look to get an attorney to represent you in finding a business, network to find opportunities, or reach out to specific businesses you want to target.
What is a UCC Lien, and How Does it Affect Me?
A UCC lien is a public notice that someone is using some asset, or group of assets, as collateral for money that is owed to them. Whenever you take out a loan to buy a business there is a high chance that your lender will want your business assets as collateral.
If you pledge your assets as collateral, the lender will likely file a UCC lien to make sure any future financing you want to get is aware of their claim to your assets. It doesn’t hurt your business unless you’re trying to get additional financing. You can learn more by reading our guide to UCC liens.
Will I Have to Sign a Personal Guarantee to Buy a Business?
Unless you’re able to pay cash for the business you’re buying, it’s likely that you will sign a personal guarantee. Personal liability is often hidden in limited liability companies and other corporations today, that your lender wants access to other assets in case you default. They also want to make sure you’re fully engaged with the success of the business.
Bottom Line: How to Get a Loan to Buy a Business
The question of how to get a loan to buy a business has a number of answers. In the end, financing a business acquisition requires careful planning and analysis of all your options. SBA loans are a good place to start but expect a lengthy process of document collection and lender review that can last 120 days or more.
If you don’t meet the requirements of a bank loan or SBA loan, or if you just don’t have time for the lengthy underwriting process, you can consider using retirement funds in a ROBS, negotiating seller financing, or tapping the equity in your home. The right one will depend on your situation, but a ROBS can give you the flexibility and funds you need within a few weeks. You can setup a free consultation with our recommended ROBS provider, Guidant, today.