For individuals looking to acquire an existing business, a loan is usually necessary to obtain the required capital. Not only can the loan be used to purchase the business, but it can also give a borrower the cash flow necessary to ensure a successful start to the business. Typically, a down payment of at least 10% will be needed. Interest rates start at 5% and go up from there, with a term of between three and 25 years.
Before beginning the process of getting a loan to buy a business, the experts at Guidant can assist with the valuation of the company being acquired. Guidant also has funding options, including rollover for business startups (ROBS) financing. Check out Guidant’s website for more information or to begin the funding process.
The following are the seven steps needed to get a loan to purchase a business.
1. Gather the Required Documentation
No matter which type of financing a business owner goes with, there will be specific documentation required. Not only will the lender require this documentation, but it is also likely that the company being acquired will want to verify this information to make sure the potential buyer has the assets to complete the business purchase.
The exact documents required will vary depending on the financing option, with Small Business Administration (SBA) loans typically requiring the most documentation.
When applying for a loan to buy a business, the documentation usually required includes:
- Purchase contract for the business
- Business and personal tax returns (prior three years)
- Balance sheet and profit and loss statement (year-to-date)
- Information on outstanding business debts
- Complete list of business assets, including year, make, model, mileage, and hours
- Rent rolls if the business has tenants
- Business lease
- Organizational documents for the business like articles of incorporation
- Business licenses
2. Make the Initial Inquiry
Once the documentation has been gathered, the potential buyer must reach out to the business to express interest in purchasing the company. At this point, a nondisclosure agreement (NDA) will likely be required so basic information about the business can be shared between the two parties. Next, the potential buyer should review this information and research any additional information. This process should take around a week.
3. Make a Data Request
If the potential buyer wishes to continue after the initial investigation, a data request usually follows. This allows the buyer to request records such as financial statements. This information may also be required by the lender chosen in the next phase of the process.
Researching the valuation of the business through valuation calculators will allow the potential buyer to begin planning for the upcoming loan request. In addition, it will allow the buyer to determine the amount of financing needed and what kind of down payment may be required.
4. Choose the Right Type of Loan
Funding Type | Best For |
|---|---|
SBA Loan | Prime borrowers looking for the longest repayment terms and lowest interest rates |
ROBS | Funding a purchase or down payment with at least $50,000 in a deferred retirement account |
Seller Financing | Sellers willing to help the buyer—used in combination with other financing |
Home Equity Line of Credit (HELOC) & Home Equity Loan (HEL) | Borrowers with at least 20% equity in their homes and relatively good credit |
SBA Loans
The top choice among business acquisition loans is an SBA loan. SBA loans have the most competitive interest rates and the longest repayment terms. However, qualification can be difficult, and the process can take between 45 and 90 days.
Buying an existing business with an SBA loan is easier than using it for startup financing because the lender can look at the business’s financial records instead of relying on the projections of a new business.
Because the SBA guarantees the loan, it is safer for lenders. Even if the borrower doesn’t have enough collateral to secure a traditional loan, they may qualify for an SBA loan.
Pros and Cons of an SBA Loan
| PROS | CONS |
|---|---|
| Low interest rates | Extensive paperwork and slow process |
| Long repayment terms | Harder to qualify—will require a personal guarantee |
| Low down payment | Expensive fees |
SBA Loan Terms and Qualifications
As with traditional business loans, an SBA loan typically requires a credit score of at least 680, along with industry experience and a strong business plan. In addition, collateral may be necessary.
The loan amounts and down payment requirements for SBA business acquisition loans are:
- Loan amount: Up to $5 million
- Down payment: At least 10% to 20% of the purchase price
- Guarantee fee: 2%
- Packaging fee: $2,000 and up
The interest rates on SBA loans vary and are based on the U.S. prime rate. Those rates are updated on our SBA loan rates page.
Repayment Schedule
The maximum terms for SBA 7(a) loans to buy an existing business are:
- Inventory or working capital: Up to 10 years
- Equipment, fixtures, or furniture: Greater of 10 years or the useful life of the collateral, not to exceed 25 years
- Commercial real estate: Up to 25 years
How to Qualify for an SBA Business Purchase Loan
It can be challenging to qualify for an SBA loan. Generally, there are five factors the SBA will consider:
- Personal credit score: A credit score of 680 or higher will be required.
- Down payment: A down payment of 10% to 20% is likely, but some will need at least 30%.
- Collateral: Real estate is the best collateral, but other collateral, such as vehicles, accounts receivable, or other business assets, may be acceptable.
- Industry experience: The SBA prefers borrowers with industry experience.
- Financially strong business: Existing businesses with a track record of success are attractive to the SBA for loan approval.
SmartBiz is an excellent broker for SBA loans to buy a business. For more information on SBA loans or to apply, check out SmartBiz’s website.
ROBS
A ROBS allows a business owner to invest funds from a personal retirement account into a new business without paying early withdrawal penalties or income taxes. It is not a business loan or a 401(k) loan, which means there is no interest or debt to repay.
The funds can be available from a ROBS provider in two to three weeks, which is faster than an SBA loan. Because buying a business can be a time-sensitive process, acquiring funding in a shorter amount of time can increase the probability that the acquisition will be successful.
Pros and Cons of ROBS
| PROS | CONS |
|---|---|
| Faster than an SBA loan | Initial and ongoing fees can be high |
| Not a loan, so no debt to repay | Can be a risk to the business owner’s retirement funds |
| No taxes or penalties | Can be difficult to set up |
ROBS Cost and Qualifications
The cost of using a ROBS for financing the purchase of an existing business are:
- Setup fees: $5,000 at initiation
- Management fees: $130 per month
To qualify for and use a ROBS, you must:
- Contribute $50,000 or more from your retirement savings: For a ROBS to be a good choice, the business owner must have at least $50,000 in a deferred retirement account. The business owner must then be willing to use that money to fund the business through a ROBS.
- Be an employee of the business: The business owner must be a legitimate employee of the business the funds are being rolled into. A ROBS is an ideal choice for an actively managed business but not a great choice for an absentee business, such as some real estate investment companies.
- Structure your business as a C corporation (C-corp): To set up a ROBS, the company must be structured as a C-corp.
- Be able to fund the setup costs: The setup fees of $5,000 must come from funds outside of the deferred retirement account. However, the monthly fees can be paid with any funds, including the ones rolled over for the ROBS.
Where to Find a ROBS
For more information on ROBS financing, check out our article on the best rollover for business startup financing providers. In addition, we recommend Guidant Financial to assist with the proper setup and execution of a ROBS account. Check out the Guidant Financial website for more information on ROBS or to speak with a ROBS specialist.
Seller Financing
Seller financing occurs when the business owner selling their business to a potential buyer agrees to finance part or all of the purchase price. With seller financing, the seller typically finances 15% to 60% of the purchase price. This allows potential buyers with subprime credit to get better interest rates for financing the purchase of the new business.
Pros and Cons of Seller Financing
| PROS | CONS |
|---|---|
| Seller maintains a business interest, which can help maintain business relationships | Not always available |
| Interest rates will be lower than the buyer would be able to get on their own | Buyer may still have to secure partial financing elsewhere |
| Interest rates will be lower than the buyer would be able to get on their own | Seller may still want a say in the business after the sale is completed |
Other benefits to using seller financing to buy an existing business include:
- Confidence in the business is increased: Seller financing can give you more confidence since the current owner is willing to invest in your success.
- All or some of the purchase costs are covered: Seller financing, or seller carry-back financing, can be used to cover all of a buyer’s purchase or just a portion. If the seller financing only covers a part of the acquisition cost, the buyer will often make up the difference with cash, HELOC, or SBA loan.
Seller Standby Note
Some business owners will use seller financing to satisfy requirements for an SBA loan or other down payment requirements. This may require the seller to put up collateral during the term of the loan. A financial expert should be consulted throughout the process to make sure all parties are aware of the risks involved and the potential liability in the event of loan default.
HELOC or HEL
A HELOC is a revolving line of credit with the potential buyer’s home held as collateral against the loan. It is often a second lien on the property behind the primary mortgage. Money can be drawn and repaid as long as the line of credit remains open. At maturity, the line of credit can be renewed, paid off, or extended.
A home equity loan is a lump sum loan against the equity of a property, also usually a second lien on the property. This type of loan often has fixed payments, with repayment complete at maturity.
Pros and Cons of a HELOC or HEL
| PROS | CONS |
|---|---|
| Low interest rates | Reduces equity in the potential buyer’s home |
| Flexibility in the use of the funds | Puts the home at risk if the business isn’t able to repay the loan |
| Allows for multiple draws as funds are needed | Borrower may not have enough equity in the house to use the funds to purchase a business |
Terms and qualifications for a HELOC or HEL
Both types of funding require equity in the property being held as collateral. The typical requirements for a home equity loan or line of credit are:
- Equity: At least 20% equity in your home; rule of thumb is between 30% and 40% minimum
- Maximum loan-to-value (LTV): 80%, based on the appraised value of your home
- Credit score: At least 620—preferably 680 or higher
5. Sign a Letter of Intent
Once the financing has been preapproved, the potential buyer will sign a nonbinding letter of intent (LOI) showing the expected purchase offer. Upon accepting the offer, the seller will want to know how the buyer intends to purchase the business. The preapproval letter will show that the buyer is qualified for financing. At this point, initial negotiations regarding sale price and terms will take place. This process should take one to two weeks.
6. Go Through the Full Company Review
Upon signing of the LOI and while the financing process continues, the buyer will review all available information on the company they are purchasing. During this one- to two-month period, the buyer will determine whether or not to proceed with the purchase.
7. Sign the Purchase Agreement
Once financing is completed and terms agreed upon, the parties will finalize negotiations on terms and prepare closing documents. The documents will be signed, and the deal will be closed at this stage. The loan should be wrapped up before this stage so closing deadlines can be met and the deal doesn’t fall through at the last minute. It can take anywhere from a few days to a few weeks to wrap up this final stage.
Bottom Line
Potential business buyers have many options available for funding a purchase. Be sure to consult a financial advisor and a legal expert to find the best options and ensure the business is correctly set up to be purchased. SBA loans are the best way to receive funding, but it is essential to know what is required before applying. ROBS financing is also another good option. Stop by Guidant’s website for expert advice and options for business acquisition funding.
