business financing

If you’re considering buying a business in the near future, it’s a good idea to understand the different financing options that exist. Buying a business is most likely one of the most expensive and important purchases you will ever make, it is imperative to have qualified professionals guide you through the process. A knowledgeable business broker can guide you through the options and help you choose the method of financing that is right for your particular situation.

1 – SBA:

Put simply, an SBA loan is a small business loan that is partially guaranteed by the government (the Small Business Administration), which eliminates some of the risk for the financial institution who is issuing the loan.

You read that right – it’s not the SBA who is doing the lending. The SBA works with a network of approved financial institutions (typically, traditional banks) that lend money to small businesses. SBA loans can be valued from $500 to $5 million, opening SBA financing options to a wide range of businesses. Because the SBA partially guarantees the loans that these lenders extend to small businesses, lenders extend funding more frequently and with better terms than without the SBA backing.

When going through the qualification process, SBA backed lenders will take a close look at the business in question, as they will want to make sure you can repay the loan and still continue to operate the business.

SBA lenders will also look for a buyer with strong experience, 10-20% down as a cash downpayment and a solid credit score (over 680). Buyers are required to personally guarantee the loan and they may have to provide additional security in the form of assets they own.

SBA loans to buy a business have a guarantee fee, typically starting at 3% of the loan amount, and lenders may charge packaging fees of up to $2,500. There may also be other fees associated with an SBA loan to buy an existing business, such as application fees, third-party closing costs, or prepayment fees.

The upside on utilizing a SBA loan is that it is cheap money for the buyer (as compared to other options for financing a business). It also allows a buyer to purchase a business that may have seemed out-of-reach without significant financing. On the other-hand, in order to secure a SBA loan, a buyer may have to pledge a significant portion of their personal assets in addition to providing a personal guarantee.

Sellers also benefit from a SBA loan, as they will usually get of the purchase price upfront in cash (at least 80%).

When financing a business, it’s always a good idea to talk to multiple SBA lenders, as some banks prefer certain types of businesses over others.

2 – 401K/Retirement Plan Rollover:

A Rollover For Business Startups, commonly referred to as a ROBS, helps you access your retirement savings for financing a business purchase without paying taxes or early withdrawal fees – making it a great way to fund all or a portion of the purchase price.

A major upside – the speed. In a Rollover For Business Startups, the funds are generally available in two to three weeks, which is 4 times as fast as traditional bank financing. Another major positive, you’re tapping into your own money, not taking our a loan, so there is no debt and there are no future payments required by a lender.

In simple terms, you transfer your retirement account to a service company (very much like a 1031 exchange intermediary). They will act as your trustee and purchase shares of your new company.

By doing this, you can access your retirement account without having to take a taxable distribution. You can also mix this capital with other sources of funds.

The upside in this case is the buyer is completely in control of his or her funds and enters the business with little to no debt. The downside of this type of financing is that in the event the business fails, the buyer may loose her or her retirement funds.

It’s also important to note that there are a lot of rules associated with this type of funding, so it is imperative to involve a professional business broker during this type of funding.

3 – Traditional Bank Financing:

Securing funding for buying a business from a bank is very similar to SBA financing, but without the backing of the Small Business Administration. Banks like to see buyers with a strong background and an adequate down payment – usually 10-20% of the purchase price.

4 – AR Funding:

Existing businesses use AR funding to help alleviate cash-flow concerns or to help keep up with rapid growth. When funding a business, AR funding can be helpful in bridging the gap between the sellers expectations and the buyers available cash as well as provide the buyer with operating capital they may need to operate the business when they take over.

A 3rd party company will purchase some of the receivables (usually 60% or less) and charge a daily fee until they are paid. The cost of this type of financing is high; however, these are usually very short terms loans so depending on the cash needs of the parties, A/R funding is a good way to receive funds in as little as four to five days.

5 – Seller Financing:

Seller financing happens when the owner you’re buying your business from agrees to finance part or all of the purchase price. Sellers open to seller financing will typically finance 15% to 60% of the purchase price of the business they’re selling. This can help borrowers with less than prime credit profiles gain access to affordable financing they may be unable to get otherwise.

Over the past few years, seller financing has become a key element in financing a business, especially in businesses that have some level of riskiness (rapid growth, short time in business, etc). Seller financing also sends a strong message to the buyer that the seller is confident in the continued success of the business.

There is a lot of upside to this type of financing for both parties. Businesses that utilize seller financing typically close faster than those that use a more traditional bank or SBA backed loan. The seller essentially acts as the bank, so they get to make the decision with regards on who they will finance, how much they will accept, the interest rate, and the term. The seller is in the first position, so if the buyer defaults, they can take the business back quickly, without delay from another lender and get it back on track if necessary. In addition, seller financing may offer a tax benefit to the seller since they can defer some of the tax due on the business until full payment is received.

6 – Earn Outs:

Earn-out financing involves a certain dollar amount or percentage agreed on by the buyer and seller to be paid to the seller based on the performance of the company after a set amount of time has past after the ownership transition is complete. Earn-outs can be structured in a variety of ways and can be based on different financial benchmarks such as company’s revenues, gross profits or net income.

Earn-out financing is often used by companies that are in a turnaround situation, when buyers are purchasing on potential, rather than historical cash flow or when purchasing a business that is considered risky. Earn-outs are tricky and can carry risk for both parties. It is essential to have earn-outs written properly and that both parties throughly understand the terms of the earn-out.

Buying a business is most likely one of the most expensive and important purchase you will ever make, it is imperative to have qualified professionals guide you through the process. A knowledgeable business broker can guide you through the options and help you choose the method of financing that is right for your particular situation.