How to Get Financing to Buy a Business

In this blog post, we’ll explore various ways you can secure the funds needed to buy a small business. And, maybe as you read along, you will come to the same conclusion that I have in recent months -  that dream of small business ownership could just be within your reach.
‍

So, how to get financing to buy a business? Let’s dive in. 

Bank Loans

What are they? Traditional bank loans are probably the most well-known and common financing option for purchasing a business. Banks provide loans based on the business’s financial health and the buyer’s creditworthiness.

Overall Benefits of Traditional Bank Loans:

• Established Relationships: If you have an existing relationship with a bank, it might be easier to secure a loan.
• Competitive Rates: Banks can offer competitive interest rates, especially to borrowers with strong credit histories.
• Large Loan Amounts: Banks can provide substantial loan amounts, making it possible to finance large purchases.

Why Bank Loans Make Sense:

• Stability and Reliability: Banks are established financial institutions with a long history of lending, providing a sense of security and trust.
• Flexible Repayment Terms: Many banks offer various repayment options and terms to fit the borrower’s financial situation.
• Additional Services: Banks often provide additional financial services, such as business checking accounts, credit cards, and lines of credit, which can be beneficial for managing business finances.
• Personalized Service: Having an existing relationship with a bank can lead to more personalized service and tailored financial advice.

Why Bank Loans Are a Challenge:

• Strict Requirements: Banks typically have stringent requirements for loan approval, including a high credit score, detailed financial records, and a comprehensive business plan.
• Collateral Requirement: Most bank loans require collateral, which can be a risk if the business does not perform as expected.
• Lengthy Approval Process: The approval process for bank loans can be time-consuming, involving extensive paperwork and multiple rounds of review.
• Less Flexibility: Banks may be less flexible with terms and conditions compared to alternative lenders or seller financing options.

Requirements and Qualifications for Bank Loans:

• Credit Score: A strong credit score, typically 700 or higher.
• Down Payment: A down payment ranging from 20% to 30% of the purchase price.
• Business Financials: Detailed financial records of the business being acquired.
• Collateral: Banks usually require collateral to secure the loan.
• Business Plan: A comprehensive business plan demonstrating the buyer’s ability to manage and grow the business.

Seller Financing

What is it? Seller financing occurs when the current owner of the business agrees to finance part of the purchase price. This means the buyer makes payments directly to the seller over a predetermined period.

Overall Benefits of seller financing:

• Easier Approval: Since the seller already knows the business and its value, they may be more willing to offer financing to a qualified buyer.
• Flexible Terms: Buyers and sellers can negotiate terms that are mutually beneficial.
• Quick Transactions: Seller financing can speed up the closing process as it bypasses traditional lender requirements.

Why Seller Financing Makes Sense:

• Streamlined Approval: The process is often quicker and less stringent than traditional financing.
• Negotiable Terms: Terms of the loan can be customized to fit the needs of both parties.
• Lower Closing Costs: Bypassing banks can result in lower transaction fees and closing costs.
• Interest Income: Sellers can earn interest on the financed amount, potentially leading to higher overall returns.

Why Seller Financing is a Challenge:

• Risk of Default: Sellers take on the risk that the buyer may default on payments.
• Limited Cash Upfront: Sellers receive payments over time rather than a lump sum at closing.
• Due Diligence: Just as the buyer must perform due diligence on the business they are purchasing, sellers must also conduct thorough due diligence on the buyer's ability to run the business.
• Ongoing Relationship: The seller may have to maintain an ongoing relationship with the buyer until the loan is fully paid off.

Requirements and Qualifications for Seller Financing:

• Down Payment: Typically, buyers will need to provide a substantial down payment.
• Creditworthiness: While more flexible than traditional lenders, sellers will still assess the buyer’s credit history and business plan.
• Business Plan: Buyers should present a solid plan demonstrating how they intend to run and grow the business.

SBA Loans

What are they? Small Business Administration (SBA) loans are government-backed loans designed to help small businesses. The SBA doesn’t lend money directly but guarantees a portion of the loan provided by a participating lender.

Overall Benefits of SBA Loans:

• Lower Down Payments: SBA loans typically require lower down payments compared to traditional bank loans.
• Longer Repayment Terms: These loans often come with favorable terms, allowing for extended repayment periods.
• Access to Working Capital: Besides acquisition, SBA loans can provide working capital to help manage and grow the business post-purchase.

Why SBA Loans Make Sense:

• Reduced Down Payments: SBA loans generally require lower down payments, making them more accessible to buyers.
• Extended Repayment Terms: Longer repayment periods mean lower monthly payments and less financial strain.
• Working Capital: Access to additional funds for managing and growing the business after purchase.
• Government Guarantee: The SBA guarantee can make lenders more willing to approve loans, even for newer businesses or those with less established credit.

Why SBA Loans are a Challenge:

• Complex Application Process: The application process for SBA loans can be lengthy and involve significant paperwork.
• Strict Eligibility Criteria: Borrowers must meet stringent eligibility requirements, including credit score and business experience.
• Collateral Requirement: Collateral is often required, which can put personal assets at risk. However, there are some SBA loans that do not require collateral 
• Ongoing Reporting: Borrowers may need to provide ongoing financial reports to the lender and the SBA.

Requirements and Qualifications for SBA Loans:

• Credit Score: Typically, a credit score of 680 or higher is preferred.
• Down Payment: Usually, a down payment of 10% to 20% of the purchase price.
• Business Experience: Relevant business experience or a solid business plan.
• Collateral: Some form of collateral is often required.
• Debt Service Coverage Ratio (DSCR): A DSCR of 1.25 or higher is usually required, meaning the business's net operating income should be at least 1.25 times its debt obligations.

Alternative Financing Options

1. Microloans

What are they? Microloans are small loans, often provided by nonprofit organizations or community lenders, aimed at helping small businesses and startups.

Benefits:

• Easier Qualification: Microloans have less stringent requirements than traditional loans.
• Support Services: Lenders often provide additional support, such as business training and mentorship.

Requirements and Qualifications:

• Credit Score: More lenient than traditional loans, but a fair score (620 or higher) can be beneficial.
• Business Plan: A clear business plan showing how the funds will be used.
• Collateral: Not always required, but it can improve approval chances.

2. Crowdfunding

What it is: Crowdfunding involves raising small amounts of money from a large number of people, typically via online platforms.

Benefits:

• No Repayment: Funds raised through crowdfunding don’t need to be repaid, reducing financial burden.
• Marketing Advantage: Crowdfunding campaigns can also serve as marketing efforts, generating interest and publicity for the business.

Requirements and Qualifications:

• Compelling Pitch: A strong, engaging pitch to attract potential backers.
• Rewards/Incentives: Offering rewards or incentives can help attract more backers.
• Marketing Effort: Significant effort in promoting the campaign across various channels.

3. Angel Investors

‍What it is: Angel investors are wealthy individuals who provide capital to startups and small businesses in exchange for equity.

Benefits:

• Expertise: Beyond financial support, angel investors often bring valuable business expertise and connections.
• Flexible Terms: Investment terms can be more flexible than those offered by traditional lenders.

Requirements and Qualifications:

• Equity Stake: Willingness to give up a portion of business ownership.
• Business Plan: A convincing business plan to attract investment.
• Scalability: Demonstrated potential for growth and scalability.

4. Friends and Family

What it is: Loans or investments from friends and family can be a source of funding for purchasing a business.

Benefits:

• Personal Trust: This source of funding is based on personal relationships, which can simplify the approval process.
• Flexible Terms: Terms can be more flexible and accommodating compared to formal lenders.

Requirements and Qualifications:

• Clear Agreement: It’s crucial to have a clear, written agreement to avoid misunderstandings.
• Repayment Plan: A well-defined repayment plan to ensure transparency and trust.

‍
Making Your Business Ownership Dream a Reality

With these diverse financing options, purchasing a small business is more attainable than ever. Whether you choose seller financing, an SBA loan, a traditional bank loan, or one of the alternative financing methods, each option offers unique advantages to suit different needs and circumstances.

By exploring and understanding these options, you can confidently move forward with your business acquisition, turning your entrepreneurial aspirations into reality.

‍

‍