If you are looking for ways to finance the purchase of an existing business, you have several options to consider. Each option has its own advantages and disadvantages, and you should weigh them carefully before making a decision. In this article, we will explore some of the most common financing methods for business acquisitions and provide some examples of how they work.
- BANK LOANS
Bank loans are one of the oldest and most widely used forms of financing for business acquisitions. You can apply for a secured or unsecured loan from a bank or a credit union, with terms that usually range from 1 to 5 years and interest rates that vary based on your credit score, the loan amount, and other factors.
Pros: Bank loans can offer large amounts of funding with relatively low interest rates and long repayment terms. They can also help you improve your credit history and reputation as a business owner.
Cons: Bank loans can be hard to qualify for, especially if you have poor credit or lack collateral. They also require a lot of paperwork and documentation, such as business plans, financial statements, tax returns, and appraisals. Bank loans may also have prepayment penalties or other fees that increase the cost of borrowing.
Example: A buyer wants to purchase a small manufacturing business for $500,000. He applies for a secured bank loan and gets approved for $400,000 at an interest rate of 8% and a term of 5 years. He uses his personal savings to cover the remaining $100,000. His monthly loan payment is $8,113.
- SBA LOANS
SBA loans are loans that are partially guaranteed by the Small Business Administration (SBA), a federal agency that supports small businesses. The SBA offers several loan programs for different purposes, but the most popular one for business acquisitions is the SBA 7(a) loan. This loan can be used to buy an existing business or franchise, as well as specific assets or partner buyouts. The maximum loan amount is $5 million and the repayment term can be up to 25 years.
Pros: SBA loans have competitive interest rates that are capped by the SBA. They also have longer repayment terms and lower down payments than bank loans. The SBA guarantee reduces the risk for lenders, making it easier for borrowers to get approved.
Cons: SBA loans have strict eligibility criteria and require a lot of documentation and paperwork. They also take longer to process and fund than bank loans. The SBA guarantee comes with a fee that ranges from 0.5% to 3.75% of the guaranteed portion of the loan.
Example: A buyer wants to purchase a small restaurant franchise for $1 million. He applies for an SBA 7(a) loan and gets approved for $900,000 at an interest rate of 10% and a term of 10 years. He uses his personal savings to cover the remaining $100,000 and the SBA guarantee fee of $27,000 (3% of $900,000). His monthly loan payment is $11,920.
- SELLER FINANCING
Seller financing is when the seller of the business agrees to lend you part or all of the purchase price. This means that you pay the seller in installments over time, usually with interest and sometimes with a balloon payment at the end. Seller financing can be used as a standalone option or in combination with other sources of financing.
Pros: Seller financing can be more flexible and negotiable than other types of financing. It can also reduce the amount of money you need to borrow from other sources and show that the seller has confidence in the business.
Cons: Seller financing can be risky for both parties, as there is no third-party oversight or protection. The seller may also charge a higher interest rate than other lenders or impose unfavorable terms or conditions on the deal.
Example: A buyer wants to purchase a small retail business for $300,000. He negotiates with the seller to finance $200,000 of the purchase price at an interest rate of 12% and a term of 3 years. He uses his personal savings to cover the remaining $100,000. His monthly payment to the seller is $6,630.
- DEBT ASSUMPTION
Debt assumption is when you take over the existing debt of the business you are buying. This means that you assume the responsibility and liability for repaying the debt, as well as any collateral or security attached to it. Debt assumption can be used as a standalone option or in combination with other sources of financing.
Pros: Debt assumption can reduce the amount of money you need to borrow from other sources and simplify the transaction process. It can also help you leverage the existing credit history and relationships of the business.
Cons: Debt assumption can be difficult to negotiate and obtain approval from the original lender. It can also expose you to potential liabilities or risks associated with the debt, such as default, foreclosure, or litigation.
Example: A buyer wants to purchase a small software company for $500,000. The company has an outstanding bank loan of $300,000 at an interest rate of 9% and a term of 4 years. The buyer negotiates with the bank to assume this debt as part of the deal. He uses his personal savings to cover the remaining $200,000. His monthly payment to the bank is $7,494.
Conclusion
Financing a small business acquisition is not an easy task, but it can be rewarding if you find the right option for your situation. Before you decide on any type of financing, you should do your due diligence on the business you want to buy, evaluate your financial situation and goals, compare different options and terms, and consult with professional advisors such as accountants, lawyers, brokers, or consultants.
Here are some useful references or resources that can help you learn more about financing a small business acquisition:
