You may be dreaming of owning your own business. But a scary statistic might be stopping you. It is that 50% of businesses with employees fail within five years. Then getting finance to purchase an existing business may be the answer to your prayers.
Every year, more than 500,000 businesses change hands. It is expected to skyrocket in the next several years. This is as millions of baby boomers begin retiring and selling their businesses.
Many people think of starting a business from scratch. They develop their ideas and build the company from the ground up.
But starting from scratch presents some distinct disadvantages.
It includes the difficulty of building a customer base, hiring employees, and establishing cash flow. All this has to be done without a track record or reputation to go on.
In most cases, purchasing an existing business is less risky than starting from scratch. You take over a firm that’s already generating cash flow and profits.
Theirs is an established customer base and reputation. The employees know all aspects of the business.
You do not have to reinvent the wheel. There is no need to set up new procedures, systems, and policies. This is since a successful formula for running the business has already been put in place.
Finance the Purchase
We will discuss the six most common ways on how to finance and purchase an existing business. Most transactions are structured using one, some, or all of these methods.
The simplest way to finance a business acquisition is to use your funds. These funds include savings, retirement accounts, and home equity.
Although you will need to use some of your funds for the purchase, it is uncommon for someone to acquire a business using only their funds.
Otherwise, fewer people would be able to acquire larger businesses. Most buyers use their funds in combination with a business loan and seller financing. This leverage allows them to purchase larger companies.
Another way to finance an acquisition is to ask the seller to provide financing. In this case, the seller provides you with an amortized loan over some time. You pay the loan back. It is usually done from the proceeds of the business.
Business buyers like seller financing. This is because it is easier to get than conventional financing. It is more flexible.
The seller gets a vested interest in disclosing accurate performance information. It can be cheaper.
Usually, sellers are willing to finance 30% to 60% of the agreed-upon sale price. Few (if any) sellers will finance more. This is unless you are a strong buyer with substantial assets and a large down-payment.
Also, expect that seller financing will be provided after the seller has done their due diligence on you. The seller will want to see your assets, credit, experience, and business plan.
Getting a conventional loan (e.g., a term loan) from a commercial bank to finance a company’s acquisition can be very difficult. Banks lend funds against existing assets. They do not lend against business plans.
To get a loan, you must have fair personal credit, substantial assets, and a solid track record. Conventional borrowers should get a bank loan guaranteed by the Small Business Administration (SBA), as covered in the next point.
An SBA Loan is one of the best options to finance a business purchase. The SBA itself does not lend money. Instead, it provides guarantees and safety measures for banks who, in turn, can lend money to fund acquisitions.
The SBA sets some minimum qualification guidelines. But banks have the freedom to add to those guidelines as they see fit.
Generally, borrowers using a 7A loan can get up to $5M to cover most (or part) of the business’s purchase. To qualify, potential borrowers must:
- Have decent credit
- Be able to put 20% down (part of this can be paid through seller financing, see #2)
- Provide personal financial information
- Provide three years of tax information
- Show their ample experience in the industry
One standard financing structure to buy a small business is a leveraged buyout. Leveraged buyouts allow buyers to minimize the cash they invest and maximize their returns.
While leveraging assets can increase returns, it does have a significant disadvantage. If things do not go well, leverage can also maximize your losses and have a massive negative impact on your rate of return.
The transaction structure can be relatively simple. You leverage some of the business assets, such as equipment, real estate, or inventory, to help finance the acquisition.
In small firms, leveraged buyouts usually involve the combination of seller financing and a bank or SBA loan.
Assumption of Debt
There are two common ways to buy a firm. You can buy the stock or the assets. If you buy the assets, that is what you get. There are no “bad liabilities” (think “future lawsuits”). You get all assets, liabilities, and risks if you buy the stock.
Most “asset-purchase” acquisitions involve the transfer of some liabilities and assets. Assumption of existing business debt may be part of your payment to the seller.
This process can get complicated, as you often need the debtors’ approval before assuming the debt.
Common Loan Pain Points
Getting a small business loan is considerably more straightforward when you have existing revenue/data.
What is most important is finding a company you believe you can turn-around, or that fits your general budget/idea for a company.
Get an idea of the company and costs. Then you can start determining how to best purchase it (i.e., with cash, loans, revenue sharing, etc.)
Do not get caught up in how much money you have to start with. Focus on finding a company or sector that you believe is good for you or seeing as having potential!
“No-money-down” opportunities mean 100% external or seller financing.
Entrepreneurs look to acquire businesses for “no money down.” But in the real world, these transactions do not exist.
Analyze this point from the seller’s (or lender’s) perspective. They do not have any incentive to give someone 100% financing.
Sellers will have to be desperate if they want to sell. Lenders want to see new owners who have some “skin in the game.”
While some transactions could meet these criteria – they are like winning the lottery. In other words, “possible, but not probable.” It is best to prepare to put some money down.
Keep Closing Costs in Mind
Getting financing usually increases your closing costs. These closing costs, which include your contribution to the business’s purchase, come from you – the buyer.
Closing costs vary based on the type and size of the firm you are buying. Budgeting a minimum of 10% of the purchase price for closing costs is a good idea. More (20%) is usually better.
Buying a Business Online
With the advent of technology and e-commerce, you can now buy a business online also.
Various websites facilitate the buying and selling of businesses. An example of such a website is Bizbuysell.com.
These websites can be reliable. But you have to take the necessary precautions.
Many businesses are on sale for a reason. The brokers may not be lying. But the owner may be overstating numbers.
Do not trust brokers but approach them with an open mind just like you would in the offline world.
Buying the business is only half the battle. You still need to ensure you have enough funds for business operations.
If you need additional operational funding, it is best to negotiate it when negotiating the purchase. It cannot be easy to get finance after purchasing an existing business.
This section discusses common ways to finance operations.
Cash reserve is the easiest way to finance operations. Your funds can initially fund this reserve. But it should eventually be financed by the firm’s cash flow.
Pay your suppliers on net-30 or net-60 day terms, rather than paying immediately. This will improve your cash reserves
Line of Credit
Another effective way to finance operations is by using a business line of credit. This revolving facility allows you to borrow as needed and be paid down as your cash flow improves.
It is a very flexible way to finance the operations of a business. However, it can be challenging to qualify for a line of credit.
A common reason businesses experience cash flow problem is that their cash reserves run low. They cannot afford to wait 30 to 60 days to get paid by their customers.
This problem is common for firms that sell to commercial clients. It can seriously impact operations.
Improve cash flow by using invoice factoring. This solution finances your slow-paying invoices. It improves the cash flow of your business. It is easier to access than other types of funding. Also, it can work well with corporate acquisitions.
Business Acquisitions Often Use Multiple Sources of Funding
In closing, keep in mind that it is common to use more than one funding source to acquire a business. For example, a partnership of individuals may want to purchase a $7M company. You can structure this transaction by using:
- $4,000,000 from an SBA Loan
- $2,000,000 through seller financing. It may be with some standstill provisions
- $1,000,000 in purchaser funds from partners
The partners may want to include a factoring line or a line of credit. It helps to handle cash flow after the sale closes. This scenario is just one example.
There are other ways to structure this transaction, depending on its nature, assets, and purchasers’ background.
Financing the purchase of an existing business is a strategic move that you need to consider carefully. If you are in the market for buying a new business, let these tips guide you.
The business is already established and has cash flow and profits. So, buying an existing business can be less risky than beginning a new startup. Assessment of risks and failures is a crucial part of running a business.
You can also take a look at our Venture Capital Pre Screening Assessment to evaluate your business. This will also help you in getting funding for your business in just 5 steps.
Although there is a lot of finance involved to purchase an existing business, you will be rewarded when you are finally at the helm. You will be able to revitalize a stale company. You can provide fresh ideas and fresh leadership. Good luck!