Getting a loan to buy a business is a big undertaking. Banks set high standards for you (the buyer) as well as the metrics of the business, meaning that buyers need to look elsewhere for financing. When buying a business, alternative financing options include government-sponsored loans, retirement account rollovers, and more, all of which can provide more options for buyers.
In this article, we’ll show you how to get a loan to buy a business, including Rollovers for Business Startups (ROBS), SBA loans, and other financing options. If you already have $50K or more in a retirement account, consider looking into a ROBS, which lets you buy a business tax- and penalty-free. Speak to Guidant about buying a business with your existing retirement funds.
Source of Funding
No debt or interest cost because the money is yours
No taxes or penalties for early withdrawal
Setting up a ROBS is fast
Setup fee and ongoing fees are charged
Risking your nest egg
Low interest rates and long repayment terms
Down payment as low as 10%
Guarantee fee is charged
More paperwork and slower application process
Great credit score needed to qualify, 680+
(check yours for free here)
Conventional Bank Loans
Low interest rates
Requires 20-30% down payment and collateral
Great credit score needed to qualify, 680+
(check yours for free here)
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
Competitive interest rates
Reduces equity in your home
Require strong credit score, 650+
(check yours for free here)
Often inexpensive (low rates, flexible lender)
Can create tension if business fails
Before Taking On Debt, Consider a 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), 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.
SBA Loans for Buying a Business
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 it 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.
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 and the loan can come with lots of strings attached.
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:
- Your personal credit score should be above 680 (check your credit score for free here)
- 10-30% down payment
- Sufficient collateral (business and/or personal assets, real estate preferred)
- Management or industry experience (over 3-5 years preferred)
- The business you want to buy must be financially strong
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.
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
Size of 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%.
Sources of a Down Payment
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 three alternative sources for the required down payment: 1) ROBS; 2) HELOC; 3) Seller Financing
- 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. A Rollover for Business Startups lets you use retirement money to buy a business without the taxes or penalties that come with a simple early withdrawal. The funds from your ROBS can also be used for working capital, meaning you can borrow less (and ultimately pay back less).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.
- 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. And if the rate is adjustable, a bank may need to consider the potential of your HELOC payments increasing over time. There is also some increased exposure by directly borrowing against your home rather than simply pledging the asset as collateral for an SBA loan.
- Seller Financing
While not strictly considered part of your down payment, seller financing can boost your deal’s total equity injection. So if you have some funds available for a down payment but the lender would prefer more, consider looking into negotiating more seller financing.Seller financing describes a seller who is will to accept payments over time for a portion of the purchase. Typically, sellers will finance around 15-60% of the purchase price of the business they’re selling. and, in general, rates on seller financing are similar to prevailing market rates (an APR of 6-10%). These details will vary from deal to deal and are part of early negotiations.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 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 that 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.
Terms and Cost of an SBA Loan to Buy a Business
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 but up to 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.
Interest Rates & Fees
The SBA sets interest rate caps on loans that it guarantees. Typically, SBA loans will have interest rates of 6 – 7%. You can see current SBA loan rates here.
There may also be fees associated with a loan, such as application fees, third-party closing costs, or prepayment fees. SBA loans have a guarantee fee starting at 3% of the loan amount for loans over $150K.
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)
It’s vital to include a comprehensive business plan so the lender can evaluate the business’s potential. Start with the basics. Explain why you are buying the business and your qualifications. You should outline the business’s history, its current condition, and your strategy for increasing revenues and profits.
A strong business plan is especially important for turnarounds, where the business currently isn’t performing very strongly. “Banks hesitate to lend money for turnarounds,” says Mariani, “so you must show very clearly how you plan to make the business profitable.”
Include 3 to 5 years of financial projections for the business. At least the first 12 months should be broken down monthly rather than annualized. If there are seasonal patterns or volatility in the business’s revenue, be sure to explain the reasons in your business plan as well as highlight any plans to address slow or volatile periods.
To get started, you can use business plan writing software, like LivePlan, which organizes everything for you and basically prompts you from one stage to the next. It will make writing your business plan a breeze.
What Types of Deals Do Banks Offer Financing For?
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. Knowing this in advance lets you anticipate potential advantages or challenges when approaching a lender.
Professional services firms are likely to qualify for loans more easily. “Banks love doctors, accountants, and attorney businesses,” says Steve Mariani of Diamond Financial, a firm that helps businesses obtain SBA financing. This is because such firms have stable, steady income. Other businesses that have an easier time are veterinarians, dentists, and even mortuaries. Professional service firms like these can sometimes get small business loans without a down payment.
Buyouts, in which one partner buys another’s share in the business, are also excellent candidates for bank financing. Since you’re already intricately involved in the business and just want to become the sole owner, there’s less risk of change in ownership impacting business performance. If the business and personal finances are good, buyout financing is typically considered less risky for a lender.
On the flip side, banks shy away from restaurants and other businesses that tend to have little to no collateral and a higher rate of failure. “In that case,” says Manny Skevofilax, “calculate in advance if you’re willing to pledge your home or other personal assets to make up for the lack of business collateral.”
Banks will also shy away from financing anything they consider a vice industry (think gambling establishments, strip clubs, and the like). Also unlikely to be funded by a bank are businesses that kept cash earnings off the books or commingled their personal and business expenses so significantly it’s difficult to determine the business’s true financial performance.
What If I Want to Buy a Business’ 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. They require a 10% down payment and have 10-20 year terms. However, 504 loans can only be used to purchase real estate and heavy, permanent equipment, so another loan (e.g. an SBA 7(a) loan) would need to be used for the remainder of the acquisition.
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 7(a) loan for business acquisition. Buy the business and the commercial real estate. Speak with our preferred business acquisition loan provider, South End Capital. They offer long-term SBA 7(a) loans of up to $5,000,000.
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.
This means you’ll be expected to provide all of the same financial documents we listed above for the associated business. If your associated business is no longer operating or has been idle for some time, the lender will want proof the business has been dissolved or is in good standing with the state.
Note: If your associated business is owned with partners, the bank may request financial documents from partners who own a 20% or greater stake in the company to make sure their personal finances won’t negatively impact the health of your associated business.
How to Get a Loan to Buy a Business: Other Financing Options
Meeting the requirements for a bank or SBA loan isn’t easy. Not only do they set very high standards, but the process itself is document heavy, time intensive, and can last months. If you fall short, there are other options that can be used alone or in conjunction with one another:
ROBS – If you have $50K or more saved in retirement accounts, you can set up a ROBS to buy the business debt-, tax-, and penalty-free. We recommend speaking with Guidant about your ROBS options.
Seller Financing – Most sellers finance only 30-60% of the purchase price, but if you’re not able to secure a bank or SBA loan, see if the owner will finance a larger portion of the purchase price.
Personal Loans – If you have a credit score of at least 680 (check here for free), steady income, and don’t need a ton of financing to reach the purchase price, a personal loan can get you funded within days.
Home Equity – You can take out a loan or line of credit that’s secured by your home to buy the business.
Family and Friend Loans – Borrowing money from friends or family is a simple and convenient way to get the funds you need.
Finding the Right Business to Buy
It’s not unusual for buyers to look at a number of businesses before finding one that they’re comfortable making an offer on. Even then, the deal may fall through and the search will begin anew. And it’s easy to waste a lot of time browsing the many web forums and classifieds that list businesses only to come up empty-handed. While doing this kind of research works for some people, many serious buyers will reach out to a professional business broker.
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.
Looking to buy a small business? Murphy Business & Financial Corporation is a nationwide business broker with a large inventory of small businesses for sale. Plus, their sales close at roughly twice the national average. Set up a free consultation with a highly trained Murphy business broker today.
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.
If you don’t meet the requirements of a bank loan or SBA loan, if you don’t have time for the lengthy underwriting process, or if you’re lacking cash saving for the down payment, consider using retirement funds in a ROBS, negotiating seller financing, or tapping the equity in your home.