Financing the Purchase of a Business
Financing a business acquisition is very different than financing a home purchase.
The obvious difference being that you don't expect to make a living off of your
home. In a business acquisition, both the Businesses and the Buyer's financial statements
are scrutinized to make sure the transaction makes financial sense. Because lenders
loan based upon a borrower's ability to repay the loan, the cash flow of the business,
and the buyer’s knowledge of the business are critical elements in the loan decision
process. If the business does not generate enough cash flow to service the loan
and meet all of the Buyer's personal lifestyle needs, the lender will, most likely,
not fund the transaction. As a result, sometimes even a profitable business cannot
be financed because the potential borrower has personal needs, and expenses, that
exceed the income generated by the business's cash flow after debt repayment.
Lenders on real estate transactions typically lend based upon the value of the real
estate. If a borrower defaults on a home loan, the lender can simply take the property
back and sell it to cover their loan balance. Most business purchases, however,
do not have significant assets and it is common for the sale price of a business
to exceed the value of its tangible assets by a significant margin. Because most
lenders have no recourse against tangible assets, if a borrower defaults, on a business
acquisition loan, lenders routinely look for additional collateral for their protection.
The Buyer of a small business seeking a loan must be prepared to make a significant
cash down payment and pledge personal collateral, like a home, in order to satisfy
the requirements of the lender.
Here is an overview of the types of financing that are typically available for business acquisition loans:
Seller Financing
Before the emergence of significant lending activity by the Small Business Administration (SBA), Seller financing was the only choice available to Buyers. Even today, there are many reasons why Seller financing might be the right choice for a Seller. Seller financing offers limited paperwork, reduced approval times and terms that can be structured to fit a transaction instead of adhering to the terms offered by the SBA lender. Sellers can structure significant tax savings by deferring income into future years and Buyers can feel good about the Seller's confidence in them and their ability to service the debt through the business. Sellers will normally require a much higher down payment, a shorter repayment time, a Personal Guarantee along with a good Credit Report. Sellers will also retain a security interest in all of the business assets transferred. Many Sellers also require that financial statements be given to them for the first couple of years so they can see if there is a problem and help correct any issues before it gets out of hand. Most Buyers are happy to have the interests of the Seller on the same page with them during this time.
SBA Guaranteed Loan
Many local, regional and national banks and lending institutions offer business acquisition loans that are guaranteed by the Small Business Administration (SBA). If you are considering SBA financing, you should always look for a lender with SBA preferred status rating. This is your assurance that the lender routinely does these types of transactions and can readily obtain approval from the SBA for your loan. SBA loans are typically fully amortized over 10 years and are structured at the current prime interest rate plus a percentage over prime. SBA loans require many different fees ranging from packaging fees, loan guarantee fees, appraisal fees and others but often these costs can be added to the initial loan amount. Depending on the transaction, down payments on SBA loans are between 10-30% of the transaction value. SBA loans require personal guarantees, security interests in the business assets and real property of the business, if any. While many lenders state that they lend on cash flow and not assets, it has been our experience that few transactions are strong enough to obtain the financing without additional collateral being pledged. At Apeiron Business Brokers we know which lenders are active in the marketplace and are offering the most favorable terms and conditions.
Alternative Financing
In spite of what you may have heard, or read, there are very few sources for business acquisition financing other than the two listed above. Business acquisition loans that are not SBA guaranteed or seller financed are nearly impossible to obtain. Buyers should be leery of anyone offering to help obtain a highly leveraged loan with little or no down payment requirement from the borrower. Don't bother attending a "Buy a Business with No Money Down" seminar as you'll be wasting your money and time. Borrowers should also be careful of any lender, or loan broker, that requires a large amount of up front or packaging fees. Please feel free to contact us to discuss your particular financing needs.