Top 3 Financing Options for a Business Acquisition
According to UPS Stores’ Inside Small Business Survey, approximately two-thirds (66%) of Americans dream of opening a small business. However, the reality is that only a small percentage will. One of the primary drawbacks is capital. A common perception amongst many is that there is more capital required than what is available. However, there are many financing options for a business acquisition. Capital should not be a drawback.
Finding a Business to Buy
The most difficult part of opening a small business is identifying a business to either start from scratch or purchase. I honestly believe, that purchasing an existing business with a strong track record is the simplest way of entering the small business space. After identifying an existing business, consider financing options. All business transactions are open to negotiations and adjustments, so the financing options listed below may change based on the nature of the business transaction.
Peak Business Valuation, business appraiser, works with individuals across the country who plan on buying a business. An important part of the due diligence process is obtaining a business valuation. A business valuation determines a fair market value, analyzes financials, and is helpful when negotiating a purchase price. Peak Business Valuation wants you to feel confident in buying a business. Schedule a free consultation today to get started!
Financing Options
1. Seller Financing
My absolute favorite source and simplest form of financing a business purchase is seller financing. Imagine a scenario where the buyer covers an initial down payment to the seller of about 10%. Then, the seller finances the remainder of the purchase. In this scenario, the seller acts as the bank and receives monthly or annual payments over the course of a negotiated term. As a buyer, you pay more for the business than the original purchase price. However, that incremental difference gets spread over a period of let’s say 5 to 7 years.
In most of these transactions, seller financing takes the form of a promissory note with equal payments for a set period of time. Seller financing can also take the form of an earn-out. Rather than negotiated payments, the seller receives payments that tie to the performance of the business moving forward. This form of seller financing is more attractive to the seller in negotiations.
No matter the form of seller financing negotiated the buyer benefits because of the lower down payment. In addition, the seller benefits because of the residual payment structure. In doing so, it ultimately lowers the tax burden of the seller. Seller financing is very flexible and relies on terms negotiated between the buyer and the seller. Lastly, one of the greatest perks is the fact that transactions close much quicker. For more information read the Advantages and Disadvantages of Seller Financing.
2. Bank Financing
Another source of financing to consider when purchasing a small business is bank financing. Typically, the small business purchased will represent a healthy cash flow stream and/or hard assets. In most business acquisitions, the buyer focuses on buying healthy cash flow. As such, the best-suited form of bank financing would be an SBA 7(a) business acquisition loan. The reason is – the SBA 7(a) loan is a government-insured loan made by a bank or a non-bank lender. This type of loan is in place to encourage banks or non-bank lenders to lend in situations where hard assets are minimal.
Depending on the purpose of the loan, there is a required 10% minimum down payment. You can find other requirements needed to qualify for an SBA loan in another article. Much like seller financing, the down payment is reasonable. An SBA loan is a great way for the buyer to leverage their capital and for the seller to receive as much cash at closing as possible.
Peak Business Valuation, business appraiser, works with SBA lenders across the country. We provide SBA business valuations for SBA 7a loans. As such, we are happy to connect you with an SBA lender that services your industry and business need. We are also happy to answer any questions you have about buying a business and SBA financing. Schedule your free consultation!
3. Investors
If the first two financing options are off the table due to the nature of the business acquisition or the size of the business acquisition, I would suggest seeking out potential investors. Identifying potential investors takes time. If possible, partnering with someone who has capital and would rather play the part of a passive investor in the business is best.
This source of financing takes time and will pro-long a business acquisition. If you bring an investor on board, there are two things preferred to happen. The first one is to structure the business acquisition so that the purchase is partially financed with seller financing. The second is financing through an SBA loan.
Summary
As a business appraiser, Peak Business Valuation works with individuals in a variety of scenarios who plan to buy a business. We are happy to connect you with an SBA lender, provide a business appraisal before buying a business, or talk through seller financing options. If we can be of assistance, schedule a free consultation below. We look forward to working with you.
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