Buying an existing business needs careful financial planning. This article explains how to get a bank loan or SBA loan to buy a business.
A bank or SBA loan is ideal for business owners with good credit scores, 10-20 % down payment, and some business management or industry experience. As we explain further in the article, bank financing is usually complemented by other types of financing, such as seller financing, home equity loans, or retirement rollovers.
In fact, using funds in a retirement account can be a way to avoid business debt altogether. While normally you can’t touch retirement money without getting slammed by early withdrawal penalties and taxes, setting up a rollover for business startups (ROBS) avoids all of that. If you have more than $50k in a retirement account, speak to a ROBS professional at Guidant about how you can buy a business completely debt free.
Financing a Business Acquisition
No taxes or penalties for early withdrawal
Setting up a ROBS is fast
Risking your nest egg
Down payment as low as 10 %
More paperwork and slower application process
Great credit score needed to qualify, 680+
(check yours for free here)
Great credit score needed to qualify, 680+
(check yours for free here)
Low interest rate
Can negotiate terms with seller
Usually only covers a portion of the purchase price, so must be combined with other financing
Require strong credit score, 650+
(check yours for free here)
Often inexpensive (low rates, flexible lender)
SBA Loans & Bank Loans
There are a lot of questions to ask when buying a business, particularly in regards to financing. We recommend that you begin your search for financing with a bank or SBA loan because these are generally the least expensive sources of capital. It’s typically easier to get bank or SBA financing to buy an existing business than to start a new one because the business already has a track record that the lender can evaluate.
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 a bank or SBA lender is that it can take a long time to get financing and can be difficult to qualify for a loan. In the next section, we explain what you need to qualify for a bank or SBA loan.
What Do You Need to Qualify for a Bank or SBA Loan?
Your ability to get a bank or SBA loan for a business acquisition typically depends on four main factors:
- Your personal credit score (should ideally be over 680). If you know your credit score is below 680, it may be a good idea to engage a company like Lexington Law to help repair your credit.
- Business management or industry experience (ideally 3-5 years experience)
- Down payment (need 10-30 %)
- Collateral (can be business and/or personal assets).
You can think of these factors like a “four-legged stool.” If one leg is broken, the stool might still stand, but it will be shakier. Similarly, if you’re not that strong on one or two of these factors, that doesn’t mean that you can’t get a loan, but it will be more difficult.
SBA lenders will also require you to submit business plan which describes your plans for the business for the next 3 – 5 year To create a business plan, there are several high quality, inexpensive software products available. Fit Small Business recommends LivePlan , which has a 2 month money-back guarantee.
Size of down payment
Be prepared to invest some capital of your own to acquire the business. Without some “skin in the game,” a lender is not likely to give you a loan.
Every deal is different, but according to Manny Skevofilax, CEO of financial consulting firm Portal CFO, most banks expect at least 10-20 % down from the borrower and may want to see as much as 30 %. If you have a superb credit score and/or a lot of collateral to offer, you may be able to get away with 10 %.
Sources of down payment
It’s best to have cash to put down, but if that’s not a possibility for you, there are other ways to come up with the down payment.
Rollover for Business Startups
One popular way of coming up with a down payment is to use retirement funds. A Rollover for Business Startups lets you use retirement money to buy a business without taxes or 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 because there are some thorny tax and legal issues involved.
Home Equity Loans and Lines of Credit
Finally, if you’re a homeowner, you can use a home equity loan (HEL) or line of credit (HELOC) to come up with a down payment. HELs AND HELOCs are good from a cost standpoint because they have low interest rates, but they do reduce the equity you have in your home to use as collateral for the SBA loan or bank loan.
Most business acquisitions come with seller financing. In fact, banks prefer deals that include seller financing because it shows that the seller believes in the business and in the new owner. Typically, sellers will finance around 30-60 % of the purchase price of the business, and rates are similar to prevailing market rates (6-10 %). These details can vary based on the specifics of your deal.
In some cases, seller financing may be used to supplement your down payment. You will still need to bring some cash to the table. However, if your credit score is strong and other parts of your loan application are strong, you may be able to use seller financing to cover some part of the down payment.
Whenever seller financing is used alongside bank financing, the seller must be willing to take a standby position for 2 years and subordinate to the bank or SBA loan. 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 bank or SBA lender gets first dibs on proceeds from the sale of collateral.
Even if a business is highly profitable, a 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. 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. Other than that, you may also be able to use equipment, vehicles, accounts receivable, and other business or personal assets as collateral.
Collateral usually gets “discounted.” This means that the bank will assess the collateral’s value as less than its current appraised or fair market value. Why? Because the collateral can undergo wear and tear, and if the loan does go into collections, the lender will have to bear the cost of repossessing and selling the collateral. So for example, if you have real estate worth $250,000, the bank might lend you 80 % of that–$200,000. Collateral such as equipment and accounts receivables get discounted even more.
Remember, even if you don’t pledge an asset as collateral, it may be covered by a personal guarantee. Bank and 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.
What Types of Deals Do Banks Offer Financing For?
Banks like certain types of business acquisitions more 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 a stable, steady income. Professional service firms can sometimes get 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 involved in the business and just want to become the sole owner, buyout financing is less risky for a bank.
On the flip side, banks shy away from restaurants and other businesses that tend to have little to no collateral. “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.”
Loan Terms and Cost
The term of a business acquisition loan will vary depending on the type of business and what is being purchased. For example, if a majority of the acquisition involves commercial real estate, a 20-year term may be appropriate. On the other hand, if you’re purchasing only inventory and equipment, then a 5 or 10 year term may be better. The standard term for SBA loans is 10 years. Keep in mind, a longer term means lower monthly payments, but it also means that you are paying interest for a longer period of time.
Interest Rates & Fees
The interest rate for a bank loan ranges from approximately 5-10 %. The SBA sets interest rate caps on loans that it guarantees. Currently, the maximum rates on SBA loans range from 5.5 % to 8 %.
There may also be fees associated with a loan, such as application fees or prepayment fees. SBA loans have a guarantee fee starting at 3 % of the loan amount for loans over $150K.
Loan Application and Documents
When buying a business, many documents exchange hands between the seller and the buyer. When applying for a loan, you will be asked to submit financial and other documents for the business.
The purchase agreement states the final purchase price of the business, what is being bought, what actions are required by the seller and buyer at closing, and the effective date that ownership of the business is transferred to the buyer. 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.
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
- Current year income statements, balance sheets, and cashflow statements
- Information on outstanding business debts
- Rent rolls if the business has tenants
- Business lease
- Organizational documents for the business (e.g. incorporation docs and business licenses)
Include a resume for yourself and any business partners. The resume should highlight related industry experience and general experience in running a business.
It’s vital to include a comprehensive business plan so the lender can evaluate the business’ future potential.
Start with the basics and explain why you are buying a business, your qualifications to run it, and who will be managing the business. You should outline the business’ past history, its current condition, and your strategy for increasing profits, describing how the loan proceeds will help you accomplish your goals. This is especially important for turnarounds. When a business has not performed well historically and a new owner wants to take over and reverse the trend, it’s called a turnaround. “Banks hesitate to lend money for turnarounds,” says Mariani, “so you must show very clearly how you plan to make the business profitable.” For example, are you bringing a new customer base with you? Are you a competing business that already knows the industry very well?
Include 3-year financial projections for the business. At least the first 12 months should be broken down monthly rather than annualized. If there has historically been seasonal patterns in the business’ revenue or some volatility in the business’ revenue, be sure to explain the reasons in your business plan.
Writing a business plan is both an art and a science–it calls for some creativity, but there are certain things you must include. Using a business plan writing software will ensure you don’t skip over important sections. Additionally, with our preferred business plan software, LivePlan, you can select from templates designed for almost every type of business. It turns a chore into a snap.
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 business building or office.
If your acquisition includes the purchase of real estate, then you can get 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 equipment, so another loan (e.g. an SBA 7(a) loan) would need to be used for the remainder of the acquisition.
If you’re buying a business with commercial real estate, and you have a 20% cash down payment, 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.
What If I Can’t Qualify for a Bank or SBA Loan?
Meeting the requirements for a bank or SBA loan isn’t easy. If you fall short, there are other 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.
- ROBS – If you have saved enough retirement money, you can set up a ROBS to buy the business debt-, tax-, and penalty-free.
- 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.
Financing a business acquisition requires careful planning and analysis of all your options. Bank loans and SBA loans are a good place to start. If you don’t meet the requirements, however, or are struggling to come up with the full down payment, consider seller financing, retirement rollovers, home equity loans, or family and friend loans.
If you have over $50,000 in a retirement account, consider a rollover for business startups (ROBS). A ROBS allows you access your retirement money for your startup business without paying early withdrawal penalties and taxes. Speak with the professionals at Guidant to set up your ROBS.