How to Get a Loan to Buy a Business in 2019

Most people need a loan to buy a business. Borrowers should expect a down payment starting at 10%, interest between 5% and 10%, and terms between three and 25 years. Most loans have underwriting or closing costs, and borrowers should expect to pay on average 2% to 3% of the total loan amount at closing.

Before you apply for a loan to buy a business, make sure you’re paying the right price for it. Guidant’s dedicated business valuation specialists will provide you with a detailed report for $495, which includes a financing assessment and an in-depth industry analysis to make sure you don’t pay too much for your business of choice. Get started today and receive guidance each step of the way.

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Getting a Loan to Buy a Business Options

The best loan to buy an existing business for most people is an SBA loan. This is because SBA loan rates are some of the lowest, plus you can get some of the longest repayment terms (10 to 25 years). Because SBA loans are generally the best option (except for high net worth individuals who have more options), we’ll primarily focus on SBA lending.

The five most common loans to buy a business are:

1. SBA Loans to Buy a Business

Out of almost all forms of financing, SBA loans have the most competitive interest rates and longest repayment terms. However, the downside of working with an SBA lender is that it can be difficult to qualify, and even if you do, the process can take 45 to 90 days or longer.

It’s typically easier to get approved for SBA financing to buy an existing business compared to getting approved for startup financing. This is because the lender can better judge the existing business’ potential to repay a loan by looking at its track record, rather than pinning their hopes on a startup’s projections alone.

Most traditional lenders who offer multiple types of loans will often consider you first for an SBA loan because these loans are partially guaranteed by the U.S. Small Business Administration (SBA). It’s a safer bet for the lender, and if you don’t have enough collateral to secure a traditional bank loan, it could give you a better chance at getting approved.

SBA Loan Rates, Costs & Terms

An SBA loan will typically carry similar terms and qualifications to a traditional bank loan. The lender is looking for prime borrowers (680 or higher credit score) with industry experience and a strong business plan. Collateral, such as a primary residence, may also be required for approval. Understanding the rates, costs, and terms you can expect to pay will help you to make an informed financing decision.

The rates, fees, and repayment terms for SBA loans to buy a business are:

Loan Amounts & Down Payment

The loan amounts and down payment requirements for SBA loans to buy a business are:

• Loan amount: Up to $5 million
• Down payment: At least 10% to 20% of the purchase price

The down payment required for an SBA loan to buy a business is typically in the form of equity or contribution toward the business purchase loan. For example, if the business you’re buying cost $500,000, you will need to provide $50,000 to $100,000 of the funding, with the rest of the funding to purchase an existing business from the loan.

Interest Rates

SBA loans to buy a business carry interest rates that vary based on the current U.S. prime rate. SBA loan rates are typically around 7.5% to 10%.

Fees

SBA loans to buy a business have a guarantee fee, typically starting at 3% of the loan amount, and lenders may charge packaging fees of up to $2,500. There may also be other fees associated with an SBA loan to buy an existing business, such as application fees, third-party closing costs, or prepayment fees.

Repayment Schedule

SBA loans to buy a business feature terms that vary depending on the type of business and what is being purchased. You’ll get shorter terms for working capital (five to 10 years is typical) and longer terms for real estate (up to 25 years is likely). The term you are given is typically tied to how long the collateral is expected to last (e.g., a longer useful life equals a longer term).

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

Keep in mind that 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. This could increase your total cost of capital if you repay the loan over the full term instead of getting a shorter-term loan that you pay off quicker.

How to Qualify for an SBA Loan to Buy a Business

The SBA looks at a lot of information when determining whether or not you’re qualified for an SBA loan, but there are five qualifications that primarily determine whether or not you get approved. These include your personal credit score, down payment, collateral, industry experience, and the financial strength of the business you’re purchasing.

The five factors SBA lenders will consider when you apply for an SBA loan to buy a business are:

Personal Credit Score

SBA loans to buy a business generally require a credit score of 680 or more (check your score for free). If your score is lower than 680, obtaining an SBA loan will be very difficult. If this describes you, we recommend speaking with someone about how you can improve it.

Down Payment

SBA loans to buy a business typically require you to put your personal cash, known as an equity injection, towards 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, but most lenders expect at least 10% to 20% from the borrower, and may require as much as 30% down.

One popular way of coming up with a down payment is to use the money you’ve saved in a tax-deferred retirement account, and a rollover for business startups (ROBS) lets you do just that without paying withdrawal penalties or taxes. You can qualify if you have at least $50,000 in a tax-deferred retirement account. We recommend working with a ROBS professional, like Guidant, to help you through the process.

Collateral

SBA loans to buy a business, even if the business you’re looking to buy is highly profitable, typically require you to provide some collateral. 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 goes belly up and you can’t pay back the loan.

When getting a loan to buy a business, some factors to consider about collateral include:

• Real estate collateral is the most attractive: Real estate, whether business or personal, is the most attractive form of collateral because it is the most likely type of collateral to retain its value.
• Other collateral may be acceptable: You may also be able to pledge equipment, vehicles, accounts receivable, and other business or personal assets as collateral.
• Value of your collateral is discounted: Lenders typically discount the pledged collateral value to cover the potential costs of liquidating your assets and to account for any depreciation.

Industry Experience

SBA loans to buy a business require you to have three to five years of direct industry experience at a managerial level or higher. Less than that will raise serious doubts that you will need to overcome if you’re going to get the financing you need. If you don’t have that experience, then you’ll need to identify and hire a management team who has it.

If you don’t have much experience, one way to address that is with a solid three- to five-year business plan, complete with financial projections. To simplify this process, there’s easy-to-use business planning software that helps you cover all your bases. With the right software, you can end up with a great business plan even if you don’t have any tech or design skills.

Financially Strong Business

SBA loans to buy an existing business are easier to get than SBA startup loans. 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.

When evaluating if your business is financially strong, the SBA prefers:

• Operational history: The minimum time in business typically required is two to five years.
• Demonstrated profitability: The financials need to show the business is profitable.
• Growing or stable revenues: The business’ revenues need to be stable or growing. If revenue has declined, an explanation of how the buyer will improve declining revenues will be required.
• Ability to repay: If the business is not profitable or has declining revenues, the lender will likely be skeptical about the ability of the business to repay. To show the ability to repay, the business should generally have a debt service coverage ratio of at least 1.25x.

If the business you’re looking to buy is profitable, you have a 20% cash down payment, and a credit score above 680, you may qualify for an SBA 7(a) loan for a business purchase with South End Capital. They provide long-term SBA 7(a) loans of up to $5 million and offer a free consultation to help you get started.

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SBA Loan Application & Documents

When applying for a loan to buy a business, you will be asked to submit financial documents, a business plan, and personal tax returns. Your lender evaluates these documents to determine if you and the business are creditworthy. You can speed up the loan process by providing your lender with all the paperwork upfront. You can get our free SBA loan document checklist to make this easier.

The documents typically required for an SBA loan to buy a business are:

Purchase Agreement

SBA loans to buy a business require a purchase agreement that details:

• The 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 the seller will help with the 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, including whether some of what is being purchased can be considered collateral.

Before the purchase agreement, there may also be a letter of intent (LOI). This is less formal than the purchase agreement and sets out the preliminary framework for the business purchase. Many lenders use this document to get their preliminary underwriting started, but they won’t fund without an executed purchase agreement.

Financial Documents for the Business

SBA loans to buy a business require a variety of documents that the lender will need in order to evaluate the business’ financial condition. You should already have these in your possession from the due diligence process. Make sure to keep these documents accessible and well-organized after you submit copies to your lender in case they have questions.

The financial documents required for an SBA loan to buy a business include:

• Last three years business and personal 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, and hours)
• Rent rolls if the business has tenants
• Business lease
• Organizational documents for the business (e.g., incorporation documents and business licenses)
• Business plan

To apply for an SBA loan, you will need to work with an approved SBA lender. The process can take 30 to 90 days or more. Funding timelines can be shortened by preparing documents ahead of time, getting clear financial records for the business, and ensuring your credit report is accurate. Borrowers may work with a loan broker, which can speed up the application process and allows borrowers to compare rates and terms from multiple lenders.

SBA loans are available at many traditional banks, most of which also offer other types of financing that can be used to finance a business acquisition. Often the best place to start looking for a business acquisition loan is with your local bank or credit union. They typically offer the best rates, and may be able to offer customized funding options for established relationships. However, you can expect funding to take at least 30 days.

2. Rollover for Business Startups (ROBS)

A ROBS helps you access your retirement savings for financing a business purchase without paying taxes or early withdrawal fees. Plus, the funds are generally available in two to three weeks with the help of a good ROBS provider. That’s more than four times as fast as a typical bank loan. A ROBS is not a loan, so there is no debt and there are no future payments required by a lender.

The advantages of using a ROBS to finance a business purchase are:

• It’s quick: You can get a ROBS in about two to three weeks, which is quicker than a typical loan to buy an existing business.
• It isn’t a loan: Since a ROBS isn’t a loan, there isn’t any debt you have to repay.
• Your chances of success are improved: A study commissioned by Guidant Financial showed that companies funded by ROBS had a better survival rate. This can be partly attributed to the fact that a ROBS isn’t a loan and so there aren’t any payments.

As noted, buying a business is typically 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 many people who could qualify for a bank loan to buy a business choose not to. A ROBS can also be used as a down payment to satisfy the equity injection requirement of an SBA loan or other type of financing.

If you have at least $50,000 in a 401(k), IRA, 403(b), or another eligible retirement account, you could qualify to work with most ROBS providers. It’s a great way to get the money you need without saddling your business with debt from day one. You’ll simply pay a setup fee at origination and an ongoing management fee.

ROBS Cost

The cost of using a ROBS for financing the purchase of an existing business are:

• Setup fees: $5,000 at initiation
• Management fees: $140 per month

If you use a ROBS to fund your business, it’s important to note several ongoing requirements in order to remain in compliance with ERISA tax rules. Among these, you will need to create and maintain a 401(k) for your business, and allow your employees to participate. You must also be an employee of the business, and pay yourself a reasonable salary out of revenue generated by your business.

Setting up a ROBS to fund your business purchase is a complex transaction, and carries a certain level of risk. There are a number of requirements during the setup phase, as well as ongoing once you complete the transaction. That’s why we recommend working with an experienced ROBS professional so that your business is protected. As an alternative to a ROBS, you can also use 401(k) business funding when financing a business purchase.

Our recommended firm for a ROBS transaction is Guidant. They have helped over 18,000 businesses invest over $4.4 billion in starting or buying a business. You can sign up today to receive a free consultation to learn more.

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3. Seller Financing

Seller financing happens when the owner you’re buying your business from agrees to finance part or all of the purchase price. Sellers open to seller financing will typically finance 15% to 60% of the purchase price of the business they’re selling. This can help borrowers with less than prime credit profiles gain access to affordable financing they may be unable to get otherwise.

Seller financing is a good option when getting a loan to buy an existing business because:

• Confidence in the business is increased: Seller financing can give you more confidence in the business since the current owner is willing to invest in your success.
• Interest rates are similar to market rates: The interest rates on seller financing are usually similar to prevailing market rates (an APR of 8% to 12%) and are fully amortized. These details will vary from deal to deal and are typically a part of early negotiations during the sales process.
• 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 will only cover a portion of the acquisition cost, the buyer will often make up the difference with cash, a home equity line of credit (HELOC), or an SBA loan.

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 or higher, then it should be enough for many sellers that offer financing (check your score for free).

Seller Standby Note

Many business owners use seller financing to satisfy the requirements for an SBA loan or other down payment requirements. If you plan to do so, it is important to understand that the SBA (or other lender) may require the seller to put collection of principal and interest on standby for the duration of the loan term.

Often during loan closing, the seller is learning for the first time that they have to sign an SBA standby agreement, which can come as a surprise to the seller and prevent them from collecting on the loan immediately. If you plan to use seller financing to satisfy an equity injection requirement, make sure you disclose this to the seller early to avoid it derailing your deal at loan closing.

4. Home Equity Line of Credit (HELOC or HEL)

A home equity line of credit (HELOC) or a home equity loan (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 report by the Federal Reserve on small business credit access, of the small business owners who applied for home equity loans, 68.4% were approved. These funds were used to at least partially fund their businesses.

The differences between using HELOC or HEL funding to purchase an existing business are:

• HELOCs are credit lines: A HELOC is a credit line similar to a credit card that you can draw against until you hit your limit. Further, you only pay interest on what you borrow.
• HELOCs are typically variable rates: HELOCs usually have a variable interest rate that is tied to the prime rate. Borrowers may be able to lock draws into a fixed rate.
• HELs are one-time loans: You receive all the funds with a HEL upfront. Your payments are made monthly and include interest and principal on the full amount.
• HELs are typically fixed rate and fully amortized: HELs are treated as fully amortized loans, and usually have a fixed rate that is locked in when the loan is taken.

Most HELOCs have a draw period of up to ten years, with repayment terms of up to 25 years. Further, many HELOCs offer interest-only payments for the entirety of the draw period. This makes the HELOC a very inexpensive method of accessing capital compared to other personal borrowing options.

A HEL is a single-use loan, with payments for principal and interest due immediately. Unlike a home equity line of credit, which is revolving, additional funds are not available after they have been paid down. Preferred by some for the fixed interest rate, HELs are becoming outdated. As a result, many banks do not offer them, instead offering a hybrid option where draws can be converted to fixed rate loans.

To qualify for a HELOC or HEL as a small business acquisition loan, you need:

• Home equity: At least 20% to 30% equity in your home
• Acceptable credit: At least a 620 personal credit score (check your score for free)

HELOCs and HELs can be less expensive than even traditional bank or SBA loans, and the only collateral used is the home you’re borrowing against. As a form of financing, it can be very flexible. You should consult with your lender to understand any potential restrictions on how the funds can be used, as in many cases it is not a suitable form of equity for an SBA loan.

If you’re shopping for a home equity line of credit, you can reach out to one lender at a time, hoping you find a good deal. Or, you can save time, shop smart, and find a HELOC that fits from an online marketplace like LendingTree.

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5. Buy a Business With Friends & Family Financing

Borrowing from friends and family is very common for new businesses. In fact, according to the National Venture Capital Association, around 15% of all startups get a private loan from either family members or close friends. This makes using financing from friends and family a good option when searching for a loan to buy a business.

Important considerations when buying a business with financing from family and friends are:

• You might also need other financing: Buying a business that’s currently in operation may cost more than you can raise from your friends and family. However, it could be an excellent resource to get a piece of the capital required. Plus, you can pair financing from family and friends with some of the other options we reviewed.
• Formally document the loan: The transaction should be in writing and you should make payments on the money you borrow like you would with any other loan.
• Don’t mix personal and business funds: You should never commingle (or mix) personal and business funds. There’s no reason to make this mistake when opening a business checking account is so easy. Check out our recommended business checking accounts.
• Using as an equity injection for an SBA loan is tricky: You can use money obtained from friends or family to satisfy SBA equity injection requirements; however, it must either be marked as a gift (meaning you have no obligation or intent to repay it), or must be placed on standby similar to seller financing.

If you are considering getting money from friends and family for financing the purchase of an existing business, it’s important that they understand the terms of your agreement. If they believe they own part of the business or the loan will be repaid more quickly than you expect, this could hurt your business and even your relationship with them.

When friends or family make a loan to your business, they will need to demonstrate to the IRS that they are collecting interest at an acceptable level, known as imputed interest. If the interest you are paying is too low, the IRS will tax them at this imputed level.

Financing Options to Buy a Business Pros & Cons

When getting a loan to buy a business, there will always be pros and cons, and the options we’ve presented won’t work for every business. So, it may very well be that the pros of a particular option outweigh the cons since it’s your only available tool for financing a business purchase. Evaluating the pros and cons will enable you to make a good and informed financing decision.

The pros and cons of each of our top five loans to buy an existing business are:

SBA Loans to Buy a Business Pros & Cons

On the positive side, SBA loans feature low interest rates, long repayment terms, and down payments as low as 10%. The cons include the fact that you need to pay a guarantee fee, there’s more paperwork (meaning it’s slower), and qualifying is more difficult.

The pros and cons associated with using an SBA loan for financing a business purchase are:

Pros of Financing a Business Purchase With an SBA Loan

The pros of using an SBA loan to buy an existing business are:

• Low interest rates: You’ll get some of the best interest rates by choosing an SBA loan. This makes SBA loans great for long-term working capital needs. The SBA loan rates are typically around 7% to 11%.
• Long repayment terms: Depending upon the underlying collateral and loan purpose, you can get from 10 years (working capital) to 25 years (commercial real estate) to pay.
• Low down payment: Your down payment could be as low as 10%. While in some cases you’ll need to put down more money (up to 20% or 30%), the minimum amount is lower than what you’ll get from a traditional bank, where 20% to 30% is the norm.

Cons of Financing a Business Purchase With an SBA Loan

The cons of using an SBA loan to buy an existing business are:

• Minimum SBA 7(a) loan amounts: Although the SBA does not set a minimum loan amount for an SBA 7(a) loan, many banks have internal minimums. It may be difficult to find a lender that will work with SBA loans under $70,000.
• Extensive paperwork and slow process: The amount of paperwork you need to provide for an SBA loan is extensive. This contributes to a slow process. It could take up to two or three months to get funding.
• Harder to qualify: The qualifications for an SBA loan are much harder than some other financing types. You have the best chance of qualifying if you have a 680 or higher credit score, a debt service coverage ratio of 1.25x or better, and prior management experience with the type of business you’re purchasing.
• Expensive fees: There are fees associated with an SBA loan. The most substantial of these is a guarantee fee, which starts at 3% of the loan amount for loans over $150,000. You might also be charged a prepayment penalty should you need or want to repay the loan early.
• Primary residence as collateral: The SBA requires banks to fully collateralize loans to the greatest extent possible. This often means that the bank will need to use a borrower’s primary residence as collateral, if one is available. Most other forms of borrowing do not have this requirement.

Although using an SBA loan as funding to purchase an existing business can often result in lower interest rates, it will also take a very long time to get the paperwork, if you can qualify. Additionally, the interest payments and fees will affect the cash flow of your business and reduce the amount of capital you have to reinvest.

Rollover for Business Startups to Buy a Business Pros & Cons

On the positive side of using a ROBS for financing a business purchase, you won’t have any interest costs, taxes, or penalties, plus it’s a quick financing option. The cons include the fees associated with a ROBS and the potential risk this type of financing places on your nest egg.

The pros and cons associated with financing a business purchase using a ROBS are:

Pros of Buying a Business Using a ROBS

The pros of using a ROBS for financing a business purchase are:

• No interest cost: With a ROBS, you’re using your own money, so there’s no interest cost.
• No taxes or penalties: You can use a ROBS without needing to pay any taxes, and you won’t be charged any penalties.
• Quick financing option: Buying a business with a ROBS is a quick option. You can typically get your funds in two to three weeks, which is up to four times faster than a traditional bank loan.
• Can be used in combination with other financing methods: You have the option of layering a ROBS with the rest of your business purchase financing package. As an example, you could borrow the down payment you need for an SBA loan using a ROBS.

Cons of Buying a Business Using a ROBS

The cons of using a ROBS for financing a business purchase are:

• Initial and ongoing fees: While you have no interest cost, there are associated fees. A typical ROBS costs $5,000 to set up and $140 per month to manage. You’ll need to come up with this money from other sources before accessing the retirement funds you’re rolling over.
• Risk to your nest egg: If you use a ROBS, the funds you’ve saved for retirement are at risk if your business doesn’t succeed. This makes it especially important to carefully evaluate the business opportunity before saying yes.

The low cost of a ROBS plays a major role in the success of a business acquisition due to the lack of interest payments due by the business. However, it’s often best to set one up using a qualified ROBS provider rather than risking doing it on your own. As Tom Scarda, a Franchise Consultant with FranChoice, notes:

“For some borrowers, using this type of money is less expensive than traditional loans because there is no interest attached to using your own money. However, there are costs and fees associated with using the ROBS program. Moreover, to utilize the ROBS program, you will usually need to have an administrative company move the money.”

Seller Financing to Buy a Business Pros & Cons

On the positive side of seller financing, the seller is incentivized to help the business succeed, there are low interest costs, and it’s easier to negotiate your loan terms. The cons include the fact that seller financing isn’t always available and you’ll need multiple funding sources.

The pros and cons associated with using seller financing to buy a business are:

Pros of Getting a Loan to Buy a Business With Seller Financing

The pros of using seller financing to buy a business are:

• Seller maintains a business interest: With seller financing, the seller maintains a significant stake in your business. This can be beneficial, particularly if you’re trying to maintain relationships the seller built.
• Low interest rates: The interest rates for seller financing typically equal the prevailing market rates (8% to 12% APR). This is lower than some of the other financing options on this list.
• Ease of negotiating terms: You might have an easier time negotiating your loan terms with seller financing. They’re getting paid both for their business and potential interest on your loan. So, the seller has a big financial incentive to make the transaction work.
• Helps you qualify for other financing: You may not be able to get all the funds you need for financing a business purchase from family and friends. However, you could potentially get a portion of the funds and pair it with one of the other financing options.

Cons of Getting a Loan to Buy a Business With Seller Financing

The cons of using seller financing to buy a business are:

• Not always available: Seller financing may not be available for the business you want to purchase. That said, as you start your search, you need to make sure you’re not counting on seller financing and you have a backup loan ready to buy a business.
• Financing from multiple sources: Most of the time, seller financing will only cover a portion of the purchase price. This means you’ll need to secure multiple types of financing, such as from the seller and a traditional bank. This adds both complexity and potentially time to the purchase transaction. You’ll also need to make two payments.
• Seller may still want a say in the business: When you use seller financing, the seller maintains a stake in the business. This means the seller may want to have a say in how you’re running the business. Disagreements could make the situation uncomfortable.

Although seller financing ensures that the owner retains an interest in seeing the business succeed, it can also result in the seller wanting to have a say in the business. Plus, seller financing to purchase an existing business isn’t always available.

Home Equity Credit Line (HELOC or HEL) to Buy a Business Pros & Cons

On the positive side, when getting a loan to buy an existing business using a HELOC or HEL, you’ll get a lower interest rate than most other options, along with flexibility in your use of funds. The cons include the fact that your home equity is reduced and your home will be pledged as collateral.

The pros and cons associated with using a HELOC or HEL to buy a business are:

Pros of Financing a Business Purchase With a Home Equity Line of Credit

The pros of getting a loan to buy a business using a HELOC or HEL are:

• Low interest rates: The interest rates you’ll pay for a HELOC or HEL are lower than most other options on our list. For a HELOC, you’ll typically pay 5.5% to 13%, while with a HEL, the interest rate is generally 5% to 9%.
• Flexibility in use of funds: With a HELOC or HEL, you have more flexibility in how you use your funds since you’re borrowing against a personal asset.

Cons of Financing a Business Purchase With a Home Equity Line of Credit

The cons of getting a loan to buy a business using a HELOC or HEL are:

• Reduces equity in your home: Any funds you advance on your HELOC or HEL reduce your home equity. While it’s a relatively easy source of financing, you should make sure you have plans for how you’ll replenish your home equity in the future.
• Your home is at risk: You’re putting your home on the line when getting a loan to buy a business using a HELOC or HEL. If for whatever reason you can’t repay the loan, you not only risk losing your business, but also your home.

A HEL or HELOC allows you to get a business purchase loan without the extensive qualifications that are common with financing like SBA loans. However, your personal home will be at risk in the event that you can’t make payments.

Friends & Family Financing to Buy a Business Pros & Cons

On the positive side, a loan to buy an existing business from family and friends is convenient and inexpensive, plus your lender is typically flexible. The cons include potential personal problems if things go wrong, you need a network of wealthy people to make it work, and there are potential reporting problems.

The pros and cons associated with financing a business purchase with family and friends are:

Pros of Using Friends & Family for a Loan to Buy an Existing Business

The pros of getting a loan to buy a business from family and friends are:

• Requires little to no paperwork: Borrowing from friends and family is typically a very convenient option. You’ll likely have very little (if any) paperwork and you can get the funds quickly.
• Is very inexpensive: Friends and family typically charge very little. As of October 2019, per the IRS, the minimum interest rates on short-term loans (less than three years) was 1.69% and 1.86% on long-term loans (up to nine years). You should make sure your friends and family charge you interest so the IRS doesn’t see it as a gift and tax you for it.
• Can offer a large amount of flexibility: Typically, your friends and family will be very flexible should you run into times of trouble. This can be a great benefit, especially if you’re just starting out.

Cons of Using Friends & Family for a Loan to Buy an Existing Business

The cons of getting a loan to buy a business from family and friends are:

• Potential personal problems: While family and friends will typically be very flexible with you in times of trouble, which is a pro, there is an associated con. If your business fails and you can’t repay the loan, it might cause personal problems and tension. To avoid this, it’s important to treat your loan as seriously as you would with a third-party lender.
• You need a wealthy network: This may be obvious, but financing from friends and family is only available to you if those with whom you’re associated are wealthy. If you don’t have a network of wealthy individuals on whom you can call, then this isn’t an option for you.
• Potential reporting problems: Although you can typically get a loan from family and friends with little documentation, this can lead to potential reporting problems. A lack of documentation could also make other fundraising difficult, as it just doesn’t look professional.

Although your friends and family may believe in your business and your ability to succeed, sometimes, despite best efforts, businesses may fail. Unfortunately, this can lead to strained relationships and other issues, which is why it’s important that you explain the potential risks to any friends and family members who are willing to help you with a business purchase loan.

Business Loan Down Payment

If you’re borrowing money from a bank or lender to start or buy a business, they will typically require a down payment, known as an equity injection in SBA lending. Down payments typically range from 10% to 20%, due at or before loan closing. Lenders will want to know the source of the down payment, and debt is closely scrutinized.

Some sellers will require earnest money in order to begin due diligence with a prospective buyer, which can be counted toward the down payment or equity injection requirement. Equipment and asset purchases, such as real estate where the business will be operated, can be counted against any equity injection requirement. Under specific circumstances, seller financing can be used to satisfy a down payment.

Getting a Business Loan With No Money

If you’re interested in buying a business, but aren’t sure how to come up with the down payment or can’t access the required funds, you’re not necessarily out of luck. There are several ways to come up with money for a down payment, including bringing on a partner, using a rollover for business startups (ROBS), and arranging seller financing.

Some ways you can get a business loan without a down payment are:

• Bring on a partner: Consider bringing a qualified partner on board. A good partner can bring experience, as well as funding, and a strong credit background.
• Seller financing: The portion of seller financing used to satisfy the down payment may be placed on standby, as is the case with SBA financing, allowing it to be used as an equity injection.
• Personal debt: A personal loan for business purposes, including a home equity loan in certain cases, may be used in order to satisfy a down payment. The borrower must be able to show that they have outside income sufficient to cover the loan payment.
• Investment or gift: Family and friends can gift money, which can then be used for equity injection, and borrowers can also accept funds in the form of an investment. In both cases, specific documentation must be supplied.
• Use ROBS: You may believe you can’t access your retirement funds without a penalty, but that is not necessarily true. If you have over $50,000 in a retirement account, you can set up a ROBS and use that money to satisfy the down payment requirement.

When it comes to acquiring an existing business, there are relatively few lending options that don’t require a down payment, so determining which route you wish to take to satisfy the equity injection requirement is critical. Depending on which option you take, you risk giving up some control over business decisions, harming relationships, or creating additional personal debt for yourself. The trade-off is gaining access to the capital you need to buy your business.

Timeline for Getting a Loan to Buy a Business

When buying a business, there is generally a timeline that you can expect to follow before you get to closing. It’s important that you make sure your financing timeline fits into the timeline of the overall business closing process, and that you have the right documents prepared at the right time.

The typical small business timeline and process for getting a loan to buy a business is:

Initial Inquiry (Time: 1 Week)

To learn about the business opportunity, you’ll typically sign a non-disclosure agreement (NDA) in order to receive some basic information. Business brokers typically like to receive an indication of interest in buying the business within one week after receiving any preliminary data. At this stage, you should begin the process of researching potential business purchase financing options and lenders.

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. This includes documentation like its historical financial statements. This is a good time to start preparing for your loan to buy a business by gathering the required documentation and reaching out to the lenders you identified in the prior stage.

When getting a loan to buy a business, a calculator for business valuations is helpful. This is because you’ll want to know you’re not paying too much for the business. The value of your business also affects how much you can borrow. Preparing this calculation early may save you time in the long run.

By preparing some documents early and being responsive to the requests of your lender, you can increase your chances of qualifying for a loan and reduce the time it takes. Nishank Khanna, Chief Marketing Officer of Clarify Capital, notes:

“Most lenders look at three factors to determine if you qualify for a loan: credit score, time in business, and average monthly revenue. Be prepared in advance to provide records of the business’ valuation and past financial performance. To have a better chance of getting approved for an acquisition loan, you can also provide financial projections for the next 12 to 24 months.”

Letter of Intent (Time: 1–2 Weeks)

At this stage, if you want to move forward with the business, you’ll submit a non-binding letter of intent (LOI) with your expected offer. If accepted, this is when the business will want to know how you plan to fund the purchase.

You should get a pre-approval letter from the company you’re using to get your loan to buy a business 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, you’ll be able to review all available information on the company. 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 loan to buy the business during this period by working with your lender and submitting all necessary documentation.

Purchase Agreement & Closing (Time: A Few Days to a Few Weeks)

This is where a purchase agreement is negotiated, signed, and closing takes place. At this point, your loan to buy the business should be ready to fund so that you can hit your closing date and not lose the business to an impatient seller.

Documentation Required for a Loan to Buy an Existing Business

Getting a loan to buy a business potentially requires a significant amount of paperwork. This paperwork likely includes such items as your purchase agreement as well as financial information on you and the business you’re buying. As you gather the information, you should organize it in a binder so it’s readily accessible should your lender have any questions.

The amount of documentation required varies based on the type of business purchase financing you choose. An SBA loan will require the most documentation. We’ve put together a free SBA loan documentation checklist to help you gather all the required information.

When getting a loan to buy a business, the documentation you’ll likely need to provide 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 (e.g., articles of incorporation)
• Business licenses

To avoid the documentation altogether, a great option is a ROBS, as little to no paperwork is required. Our recommended firm for a ROBS transaction is Guidant. They have helped over 11,000 businesses invest over $3 billion in starting or buying a business. You can sign up today to receive a free consultation to learn more.

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Frequently Asked Questions (FAQs) About Getting a Loan to Buy a Business

This article has provided a lot of information about how to get a loan to buy a business and ways of financing a business purchase. However, some questions are asked more frequently than others, which we’ve tried to address here. If we haven’t answered your question, feel free to share it with us in the Fit Small Business forum and we’ll provide an answer.

Some of the most frequently asked questions about loans to buy an existing business are:

What types of business acquisitions do banks prefer?

Banks prefer certain types of business acquisitions over others. This is because, over time, certain businesses and industries have performed better and more consistently than others. Banks like safe businesses where the buyer has three to five years of industry experience. It’s even better if the business is established, with two to five years of demonstrated profitability.

Some of the types of business acquisitions for which banks prefer to provide small business acquisition loans include:

• Daycares
• Professional services (e.g., accountants, lawyers)
• Medical services (e.g., doctor, dentist)
• Partner buyouts
• Mortuaries

These businesses tend to always be in demand without seasonality or large fluctuations, with the exception of partner buyouts. With partner buyouts, banks feel comfortable providing financing because the buyer typically has a great deal of experience with the business.

What types of business purchases do banks not like?

Banks don’t like risky businesses or businesses with small margins. This is because there’s an increased risk of loss to the bank. Banks make decisions regarding what business types are risky by evaluating their industry, their past experience, and potential reputational concerns. For businesses with elevated risk, an alternative lender might be better.

Some examples of businesses banks may consider too risky for a business acquisition loan are:

• Vice industries
• Restaurants
• Grocery stores
• Hard to explain product-based businesses
• Businesses that rely heavily on a single customer

Unfortunately, with many of these industries, little can be done to mitigate the risks that banks perceive. However, this doesn’t mean it’s impossible to get financing in this case. As long as your business is legal, there are typically lenders willing to help you get funding.

How do I also buy a business’ real estate?

Buying commercial real estate with a business does two things: increases the business assets and collateral and increases the asking price. If your acquisition includes a real estate purchase, consider an SBA 504/CDC loan for that portion of the purchase. SBA 504 loans are typically the least expensive commercial real estate financing option.

What if I already own another business?

Lenders refer to other businesses you own as “associated businesses.” If you have 20% or greater ownership in an associated business, the lender will examine the financial health of that business. This is to ensure the associated business doesn’t pose a significant risk to your finances, including the repayment ability of your new loan.

How do I find the right business to buy?

Often, business brokers will be experts in both the buying and selling of a business. Their expertise can be invaluable for understanding the market, the available inventory, expected price ranges, typical seller financing offered, and much more. When searching for an opportunity to buy a business, it makes sense to start by finding a broker.

By providing your business broker 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 & how does it affect me?

A UCC lien is a public notice that your lender is using all or some of your assets as collateral for your loan. When you get a loan to buy a business, it’s likely that your lender will want your business assets as collateral. Your lender will file a UCC-1 to protect its interest in your assets.

The reason your lender will likely file a UCC lien on your assets is to make sure any future lender with whom you work is aware of your current lender’s claim on your assets. It doesn’t hurt your business unless you’re trying to get additional financing. You can learn more by reading our guide on 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, you’ll likely sign a personal guarantee. Personal liability is often hidden behind limited liability companies and other corporations. However, your lender will want access to other assets in case you default. It also ensures you’re fully engaged in the success of the business.

What options do I have if I don’t have enough cash for a down payment?

If you don’t have cash savings available for a down payment, there are other options available to you. Most of these options we’ve mentioned are alternatives to an SBA loan to buy your business. However, they can also be used as a down payment. One of the best options is a ROBS.

Some potential down payment options you can use for a loan to buy an existing business are:

• ROBS (Rollover for Business Startups): With a ROBS, you can access the funds you need without paying taxes or withdrawal penalties. We recommend using a professional ROBS provider, like Guidant, and only using a ROBS if you have $50,000 or more in your account.
• Cash out your IRA or 401(k): Another 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. However, it could get you access to the funds you need for an SBA loan down payment.
• 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. HELOCs and HELs offer great interest rates and generous terms, but also reduce the equity available and put your personal property at risk.

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, getting a loan to buy a business requires careful planning and analysis of all your options. SBA loans are a good place to start, but you should expect a lengthy process of document collection and lender review that can last up to 120 days or more.

When considering how to get a loan to buy a business, you can use a ROBS to fund your purchase or as a down payment for an SBA loan. It can give you the flexibility and funds you need within a few weeks. You can set up a free consultation with our recommended ROBS provider, Guidant, today.

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