How does a Buyer get money to Buy a Business?
In pursuing the acquisition of a company you must first determine your options for paying for it. Although the simplest answer is to pay all cash, there are other options for leveraging your money so that you can acquire a larger company than you could otherwise do by paying all cash. There are 3 basic options that are available to most of us when we are ready to purchase a company:
- Pay All Cash
- Seller Financing
- Small Business Administration (SBA)
Business Acquisition Loan
Let’s talk about each one here.
PAY ALL CASH. First of all, paying all cash is the simplest solution since it will entail the simplest transaction. You will not have to carry a note or pledge assets and you will not have to pay any interest on the loan. By the way, you will need working capital after the business purchase besides the cash with which to buy it. However, most business Buyers do purchase companies using some sort of leverage including Seller financing and SBA loans.
SELLER FINANCING. A seller desires all cash in nearly all cases. Very often that is prohibitive for the buyer so the seller often considers “taking back paper” by giving the Buyer a loan. Things to consider include the fact that the seller does not know if the Buyer can succeed as the new owner so he is hesitant to make a loan without doing a substantial investigation into the Buyer’s abilities and background from strong credit to work experience. Remember, in this case the seller is in the roll of being a bank for the Buyer so he will ask for the same assurances that a bank would request such as collateral and personal guarantees. As a rule of thumb a seller will lend no more than 50% of the transaction and usually with terms that include a relatively short payback period.
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SBA LOANS. Suffice it to say that commercial banks almost never make conventional loans to new business Buyer based on the business alone (banks don’t know how to re-possess and run a business if the owner defaults). Hence, the only other way to leverage a business purchase via bank loan is to obtain a Small Business Administration loan. This type of loan has a major advantage because you can often get up to 80% financing. The down side is that it can add quite a bit of time to the transaction elapse time (30 to 60 days). In essence, the U.S. Government (SBA) guarantees a business loan made by a local bank to a “qualified” Buyer of a business. Qualification is dictated by the SBA and the local bank acts as the SBA’s agent. They look for four general conditions to make a loan.
- Does the company to be acquired make enough money to service the debt and still afford the buyer with enough money left over to live on?
- Does the Buyer have good credit (usually at least a high six hundreds FICO score)?
- Does the Buyer have a good ability to run the business that is the object of the purchase?
- Does the Buyer have enough collateral between business and personal assets to guarantee a reasonable portion of the loan?
Although not all of these criteria are mandatory to complete an SBA loan, the closer to meeting all criteria, the better.
Approximately 50% of my transactions are based SBA loans, 30% owner financing , and 20% are all cash.
Of course this is just a brief outline of financing issues that are associated with buying a business. Please call or email me with any questions.