Once you find a business you want to buy, it is important to have adequate financing in place to start your venture. Many opportunities fall through because there is not enough funding and/or the deal takes too long to close. Below are several options for financing a business.
Most financial institutions offer loans guaranteed by the SBA. This type of financing is highly sought after as it has low-interest rates and competitive terms. The Small Business Administration (SBA) offers these loans indirectly through partnering lenders. These may include banks, credit unions, and other financial institutions.
Lenders have the incentive to finance small businesses this way as the SBA guarantees up to 85% of loans less than $150,000 and 75% of loans more than $150,000. There are a variety of loan programs that tailor to the different needs of growing businesses. The downside is this type of financing often requires a decent down payment and the approval process can be extensive.
Commercial loans are attractive to buyers as the turnaround time is much faster than SBA loans. A commercial loan is a debt-based funding agreement between a business and a financial institution. These loans are best for established businesses with strong credit scores and cash flows. Terms are typically longer than two years with consistent monthly payments. By having access to funds faster, the deal takes less time to close. But lenders often require a down payment and collateral.
Many individuals prefer seller financing as it is often easier to negotiate between the seller and buyer. Here the buyer and seller work out an agreement where the buyer makes monthly payments to the seller in exchange for ownership of the company. Often, a down payment is made and a promissory note signed which outlines the total number of payments that are due overtime. Typically, the time frame for seller financing is 5 -7 years. The promissory note also outlines the consequences of defaulting on the payments and what the interest rate will be.
One of the main advantages of seller financing for a small business owner is that it makes the business more attractive to potential buyers. Many buyers do not have the cash necessary to pay a lump sum and bank loans can be difficult to get. Seller financing is often quicker and is less hassle than obtaining funding elsewhere.
Some individuals prefer to borrow finances from associates, acquaintances or family members. However, this kind of funding can get messy if a party does not uphold the terms. On the other hand, this type often has minimal or no interest rate.
Rollovers for Business Start-ups (ROBS)
Rollovers for Business Start-ups, also known as ROBS for short, is a method of purchasing a business by using your retirement account funds. This funding option allows you to tap into your retirement funds tax and penalty-free.
Individuals use ROBS when they do not have enough cash to buy the business outright or can not qualify for other loan options. In addition, it can be a good option for those who do not want to go into debt or leverage their home or other personal assets.
To have a ROBS, you need to form a C-corporation. The existing retirement accounts are then rolled into a new 401k plan under the C-corporation. The 401K or other retirement accounts used then become a shareholder. Keep in mind a C-corporation does have different tax implications than a sole proprietorship or LLC. So be sure it is a good fit for your business.
The drawback of this method is that ROBS can be risky as you use your retirement to buy the business. If the business fails, you may not have a retirement nest egg. Since you commit your retirement to finance the business, you also risk losing potential gains and compounding interest.
Other Financing Options
There are a variety of other financing methods to consider when buying a business. This includes cash financing, a combination of cash and debt, personal debt, among others.
Funding can be very beneficial when buying a business. The most popular options for financing a business are commercial term loans or SBA loans. However, there are a variety of other options that may be a good fit. Seek only enough funding to cover your needs. To know how much funding you may need, work with an accountant or financial professional who can help you predict when you will need funding and how much.
Peak Business Valuation provides business valuations to help determine how much financing you need to buy a business. We also work with a variety of businesses to help identify ways to increase value and grow the business. We would love to talk with you about financing a business and welcome any questions you may have. Feel free to reach out by email or through a phone call.