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 of those dreaming to open a small business will. One of the primary drawbacks is capital. A common misconception amongst many is that more capital is required than what’s available.
Capital should not be a drawback. There are countless financing options that exist today. What should be considered the most difficult part of opening a small business should be identifying a business to either start from scratch or purchase. I honestly believe, that purchasing an existing business with a strong track record to be the simplest way of entering the small business space.
Once an existing business has been identified, 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.
1. Seller Financing
My absolute favorite source of financing and one of the simplest forms of financing a business purchase. Imagine a scenario where the buyer covers an initial down payment to the seller of about 10%, and 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, but that incremental difference is 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 are tied to the performance of the business moving forward. This form of seller financing is more attractive to the seller in negotiations.
No matter what form of seller financing is negotiated, the buyer benefits because of the lower down payment. In addition, the seller benefits because of the residual payment structure, which 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.
2. Bank Financing
Another source of financing to be considered when purchasing a small business is bank financing. Typically, the small business being purchased will represent a healthy cash flow stream and/or hard assets. In most business acquisition, the buyer is focused 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 being, is that 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, a minimum down payment of 10% is required. Other requirements for qualifying for an SBA loan are documented 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.
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 and when an investor is brought on board, structuring the business acquisition so that the purchase is financed partially with seller financing and/or through an SBA loan is preferred.