Let’s begin with a quick question: Sam wants to start his own business from scratch, while Mary wants to acquire an existing business – but both need to secure financing in order to do so. Which one will have an easier time securing their loan?
While no guarantees can be made, it is probably the case that Mary, who wants to acquire an existing business, will find it easier (or at least less daunting) to get a loan than Sam, who needs to fund a start-up.
Why is that though? If you think about it, it all comes down to risk. That is what prospective lenders want to minimize – the risk of business failure and the resultant failure to repay the loan.
Loan defaults are simply less likely when funding an existing business as that business has established themselves in the industry, has acquired a customer base and already has cash flow and possibly assets (such as equipment, property, buildings, etc.). A start-up has none of those things, and as we all know, there is a high failure rate with new business start-ups.
Especially in certain categories – such as with restaurants – lenders may be much more willing to fund an existing business than take on the increased risk of funding a brand-new business. So it makes sense to give consideration to buying (and securing financing for) an existing business in today’s economy.
Where Can You Turn? Types of Business Acquisition Loans
SBA Loans: These are loans that are “backed” by the Small Business Administration of the United States government. The SBA does not lend out money, but if you can qualify, they will be willing to extend a guarantee to your lender that, if you default on the loan, they will step in to pay most of it off. This eliminates much of the risk to the lender, as the loan is guaranteed by the full force of the U.S. government.
Borrowers will turn to SBA loans because, if they can qualify, they will get very good loan terms – a good interest rate, and typically better repayment arrangements and lower closing costs than what traditional lenders offer. You should be aware that you will need to be a well-qualified borrower with a good credit score and a record free of recent business bankruptcies. The upside is that if you are looking to purchase an existing business, and that business is doing well, it may be easier for you to qualify.
Conventional Bank Loans: If you want to go the traditional route, then a trip to your local bank is where you need to start. If you are going to seek a traditional bank loan, you should be prepared to jump through a lot of hoops, as banks can be reluctant to make conventional loans, especially for smaller businesses (those that make less than $2 million in yearly EBITDA). Some buyers may decide to go this route if they have personal collateral that they can leverage versus the loan, such as a stock portfolio. Rarely, though, will a lender make you a conventional loan without a significant amount of assets and no personal guarantee for a small business purchase. Your situation may be helped by the fact that you are trying to purchase an existing business, but you will still need to prove that you have the knowledge to successfully manage the business, have good (if not great) credit and a good reputation among creditors. Banks vary in what documentation they require as well as the terms that they offer, so it would be a good idea to shop around for the best terms you can get.
Seller-Side Financing: As noted, traditional lenders can be very picky about who they are lending to, and even government-backed loans like SBA loans come with lots of red tape. If you are not sure that these types of loans would be good options for you (or if you have tried these lenders and were denied) you still have options. One of those is to see financing from those who are selling their business.
Typically, with seller financing the seller will require a down payment and the rest of the money will come to them over time, in the form of monthly/quarterly payments, at a set interest rate. An advantage of this type of loan is that the loan payments can be made from the income of the business, which will not require further up-front funds to be made available.
Interestingly, not all sellers of businesses are looking to get all their money at once from the sale, and are willing to consider financing the new buyer as it will give them, at least for a while, an income stream. There is also usually less paperwork and red tape involved in seller financing as the two parties are dealing with each other directly without a third-party lender being involved.
Most often, sellers want most, if not all of their money upfront. Why wouldn’t they? While it is common for the buyer to ask the seller for some form of a seller note, this is typically less than 25% of the total purchase price, and usually is about 10%. The rest comes from the buyer’s own equity down payment and a bank loan.
ROBS Payout: Perhaps you have a tidy sum of money set aside in your 401K. Is it possible to tap into that and use it to fund your business purchase? Yes it is, if you apply for a Rollover for Business Startups (ROBS) payout. Technically, this is not a loan at all, but a withdrawal from your accumulated 401K funds. Unlike other withdrawals from 401K funds that incur a penalty and make those withdrawals subject to taxation, ROBS payments are free from taxes and there is no penalty for an early withdrawal, which saves you money.
Also, again because a ROBS payout is not a loan, there are no monthly repayments or other payment terms to meet. You are not taking on additional debt, either personal or business, with a ROBS payout. Keep in mind though that you are using up monies set aside for your future retirement, and you will need to pay an attorney or ROBS provider to handle the paperwork. You should also consider if the maximum amount you can withdraw will be able to cover all your financing needs. A ROBS payout can also be used along with a loan to get you all the money you need to do the deal.
For a ROBS to work, you will need to be starting a “C Corporation” business entity – one that allows for the ownership of stock. If the business to be purchased does not already have one, a company 401K plan will need to be created. This 401K plan will receive the funds from the buyer’s existing 401K account. Those funds are used to purchase stock in the company, with the stock purchase freeing up that cash to be used by the business.
Finally, keep in mind that there is no reason to restrict yourself to just securing one type of loan. Often you can put together a package for financing that includes several different types of loans, with money coming from different sources. For example, you may be able to secure a traditional bank loan as well as get some funds from the seller. Or you may be able to secure an SBA loan and also contribute some of your own personal funds.
