Financing a Business Purchase
When purchasing a business, there are multiple financial options for buyers: all cash, third party financing, and seller financing. As you explore the business you will discover which options the business qualifies for. Most transactions are a combination of several of these financing methods. At Gateway, we strive to educate you about the process so that you can make a sound decision. Contact your Gateway Broker if you have questions.
- Sellers love an all cash at closing deal.
- Paying all cash for a business is the quickest way to close on a transaction
- Giving the Seller all cash at closing generally results in a lower purchase price.
- Paying all cash for a business is the quickest way to close on a transaction.
- Buyers who pay all cash have a higher risk tolerance than other Buyers.
- According to a transactional database with over 10,000 transactions, Buyers paid all cash less than 4% of the time.
- This option is best if you are debt averse or are in a hurry to close on the purchase.
Conventional Bank Loans
- Conventional bank loans do not have the SBA Loan Guarantee.
- Without the guarantee, banks want you to fully collateralize the loan. If you are purchasing real-estate, heavy equipment, or if you have enough personal assets to fulfill this requirement, this option is for you.
- Down payments range between 25 to 35 percent of the purchase price.
- Loan fees and terms will be more favorable when fully collateralized
- The only intangible assets attractive to banks are accounts receivable, which they will finance between 80 to 90 percent.
- The Buyer will have to personally guarantee the loan.
- Success rate for securing a Conventional Loan for a business acquisition is less than 20%.
- This option is best if you have substantial physical assets and a high personal net worth.
SBA Bank Loans
- The Small Business Administration (SBA) does not lend funds, they simply guarantee loans. In order to be approved, business acquisition loans must qualify based on both bank requirements and SBA requirements.
- The majority of the analysis is based on the historic performance of the business.
- The determination to lend is based on the tax returns of the business; to a lesser extent the buyer’s credit worthiness.
- SBA backed loans have long amortization periods (up to ten years without the purchase of real estate; up to 20 years with the purchase of real estate).
- Up to 80% percent financing with 7a and 504 loans. Lenders are guaranteed for 75% of the loan amount.
- Asset based SBA backed lenders finance transactions with real estate or large fixed assets as collateral for the loan.
- Cash flow SBA backed lenders finance transactions based on the strength of the business’ tax returns.
- In order to obtain a SBA Loan, there must be documented cash flow to cover new owner salary, service the debt and have a 1.25 debt service ratio.
- Buyer will also have to personally guarantee the loan.
- This option is best if you want to leverage your available cash, and the tax returns of the business document the profitability of the business for three years.
Seller financing is perhaps one of the simplest and fastest ways to finance the acquisition of a business. It is greatly dependent on the Seller’s willingness to participate. Is Seller willing to take a risk on you, the Buyer? What are Seller’s tax considerations and cash needs? The terms offered by Sellers are usually more flexible and more agreeable to the Buyer than those from a third-party lender. A portion of Seller Financing can make it easier to secure financing from Conventional or SBA backed lenders.
- The amount of the down payment is critical to the Seller.
- Buyer must show the Seller they have the skills to be successful.
- Seller will ask for the same information as a bank to determine the buyer’s credit worthiness.
- As a general rule of thumb: expect to pay 1 to 1.5 times Annual Seller Discretionary Earnings.
- Operating capital is usually not included with this type of loan.
- All terms are negotiable: price, down payment, interest rate and length of loan.
- Seller financing is a much less expensive way to borrow money.
- Buyer will have to personally guarantee the loan.
- This option is best if Seller has maximized their lifestyle while minimizing their tax liability i.e. the tax returns for business are not strong enough to secure a SBA backed loan or a Conventional loan.
Using your Retirement Funds to Purchase a Business
- Pension, profit sharing, 401(k), 403(b), other retirement plan and rollover IRA money may be used to fund your business acquisition, franchise opportunity or business start-up.
- This can be done without paying taxes or penalties.
- This option is best for you if you have a pension, profit sharing, 401(k), 403(b), other retirement plan and rollover IRA money with a former employer.
- The Employee Retirement Income Security Act of 1972 (ERISA) has an ironclad “anti-alienation clause,” this means that the future pension may not be used as collateral for a loan. If it is so pledged, it is deemed to be a distribution, therefore taxed.
- Mezzanine financing is more commonly used for larger transactions.
- Mezzanine financing is the combination of debt and equity financing that is typically used to finance the expansion of existing companies.
- Can be used to finance a shortfall between conventional lending, down payment and the purchase price.
- Provided to the borrower very quickly with little due diligence on the part of the lender and little to no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.
- This option is best for you on larger transactions along with a Conventional Loan.
- Venture Capitalists (VCs) primarily invest in high growth potential companies promising a high Return on Investment and much greater risk
- Their investment usually requires equity
- This option is primarily for businesses with great potential for aggressive growth and profitability
- This option is best for you if have “Big Potential” with little proven track record.
- Angel investors are family, friends or coworkers who believe in you and are willing to invest in you.
- Angel investors can be used for small or large transactions.
- This option is best for you if have a wealthy benefactor.
Gateway’s brokers are always willing to assist business owners and prospective business buyers with education, resources, and guidance through the process of buying and selling businesses. We are here to answer any questions to make the selling & buying process a smooth transition. Call or Email for a free consultation.