If you’d like to finance your purchase of an existing business, here’s what you should know to give yourself the best chance of qualifying for the funding you’ll need.
Step 1: Choose the Best Business Acquisition Loan for Your Needs
Fortunately, you can use many different types of financing to purchase an existing company. Each of them has its own advantages and disadvantages. These are some of the best options to consider.
Traditional Term Loans
If you can qualify for a bank loan from a traditional financial institution, that’s likely one of the best ways to finance your business purchase. If you already have a good relationship with your current bank or credit union, start your search there.
You can get the funds you need to cover a significant portion of the business’s value, then pay off the loan amount and interest in fixed payments over a reasonable loan term.
Bank loans tend to have relatively affordable interest rates and monthly payments. However, you’ll have to meet pretty strict criteria to qualify for one, including a good personal and/or business credit score and financial foundation.
SBA Loans
If you can’t get a bank loan on your own, try your luck with an SBA loan. The Small Business Administration (SBA) helps make business financing available to companies that demonstrate an inability to qualify for private funding.
The SBA generally doesn’t fund these loans themselves, but they insure a portion of the balance, making them less risky to lenders. As a result, you may qualify for an SBA loan when you can’t get traditional lenders to work with you otherwise.
SBA loans also come with additional advantages that make them an even better loan option than traditional term loans. That includes capped interest rates and longer-than-average repayment terms.
For the fastest results, consider an SBA Express loan. The SBA will respond to your application for the business line within 36 hours.
Seller Financing
Another great strategy for purchasing a business is negotiating financing directly with the seller. They’ll receive a steady income for a few years and pocket some extra money in interest, which some may find attractive.
It’s also beneficial in many ways for you as the prospective buyer. You can likely negotiate a lower interest rate easier than you could with a traditional lender and avoid some of the fees they often charge.
In addition, you won’t have to suffer through the formal underwriting that’s necessary when getting a loan from traditional sources. As a result, the transaction should go through more quickly.
Keep in mind that many business owners are unwilling to finance the entire purchase price of their company, so you’ll still need to provide a significant down payment to supplement your seller financing.
Equipment Financing
You can’t buy a whole business with equipment financing, but it might help you finance a portion of the business. If a significant portion of the business’s value is in its property and equipment, an equipment loan can be a viable way to finance part of your purchase.
Equipment financing is a type of asset-based funding that uses the equipment you’re buying as collateral. It’s a lot like using real estate to secure a mortgage.
Because lenders can always seize the underlying asset to recover their losses if you default on your debt, they’re typically more comfortable with this kind of financing than an unsecured loan.
As a result, it may be easier to get credit approval for an equipment loan despite having a bad credit score.
Step 2: See if You Qualify for the Loan
Before you apply for any financing option, double-check that you’re qualified for the loan. Some lenders will prequalify you as a buyer before you even begin your search.
In general, loans from traditional financial institutions are the most difficult to get. They’ll have the highest credit score requirements and often do the most extensive underwriting.
Be aware that lenders will also want assurance that you’ll manage the business effectively once you become the new owner. Be ready to demonstrate to them that you have expertise in the business’s industry.
For example, it might be tough to convince a lender that you’re going to be able to run an auto repair shop if you’ve been working as a nurse for your entire career.
You should also confirm that you have sufficient funds to provide the requisite money down for the purchase. Lenders will only finance a percentage of the business’s value to limit their risk, so you’ll need to provide some cash upfront.
Step 3: Prepare the Documents and Apply
Once you’ve chosen your financing type and determined that you have a good chance of qualifying, it’s time to apply. As you might expect, it can be a particularly intense process since the lender needs to review both you and the business you want to buy.
Here are some of the documents you’ll likely need to provide:
- Bank statements for you and the business
- Tax returns for you and the business
- Financial statements for the business
- Valuation of the business
- Proof of any necessary licenses to operate
Of course, the requirements vary depending on what lender you choose and the business you want to buy. You’ll have a better idea of what you need once you begin the loan application process. If you need help, it’s a good idea to work with an accountant and business broker.
The time it takes for the lender to complete the underwriting and approve or deny you also depends on what type of loan you pursue, so make sure you consider that when choosing a financing option.
Things That Lenders Look For
When you apply for a loan to buy a business, the lender must analyze you and the company in question. To do so, they’ll look at your finances and creditworthiness as well as those of the business. Here’s an in-depth explanation of what they’ll consider.
Personal Finances and Credit Scores
First and foremost, your lender will need to assess your qualifications as a prospective borrower. That involves reviewing your personal finances and credit history.
When analyzing your finances, they’ll primarily look at your tax returns and the supporting documents, like your bank statements. If you’re already a business owner or independent contractor, they’ll also want to see your relevant financial statements.
Lenders want to confirm that you can afford the future payments on your loan. While you’ll likely do so partially with your profits from the new business, they’ll also want to know about your other income sources.
The process of underwriting your personal credit shouldn’t hold any surprises for you. They’ll initiate a hard inquiry, pull your credit report, and check your credit score.
It’ll probably be a FICO score, the generic version of the most popular scoring system. If you haven’t reviewed your credit report for errors and checked your FICO Score recently, it’s a good idea to do so before you apply.
You can get free copies of your credit reports and FICO Score from AnnualCreditReport.com and Experian, respectively.
Ultimately, every lender wants to be as confident as they can be that you’ll pay them back. When reviewing your personal finances and credit, they’ll look for any red flags that might indicate otherwise.
Finances and Documents of the Business You Want To Acquire
When you buy a business, lenders need to analyze its finances and credit as much as yours. You’re going to be absorbing the business’s assets, taking over the operations, and using them both to pay back your loan, after all.
As a result, the lender wants to know that you’ve valued the business accurately and that you’re going to be able to generate a profit. To do this, they’ll look at things like the following:
- Valuation of the business: Before they can approve you for an acquisition loan, a lender needs to know how valuable the underlying business is. They’ll want to keep their loan-to-value ratio at a level that’s safe for them.
- Financial statements: Lenders want to know what assets you’re acquiring and whether the business is currently generating a profit. The risk of lending to you increases if you’re buying a business with negative cash flow because you think you can turn it around.
- Business credit scores: The creditworthiness of the business you want to acquire can also impact a lender’s willingness to finance your purchase. They’ll check the company’s business credit scores if it’s established any.
- Future business plan: Lenders need to know that you’re not going to run the business you’re acquiring into the ground. They’ll want to hear your plans for the next few years so they can be confident you’re going to manage it well.
Anything you can do to show your lender that the business you’re buying is a good investment and that it will be in capable hands when you take over will help your chances of qualifying.
Collateral and Balance Sheet
In addition to confirming that you’re going to be able to use the profits from the business you’re acquiring to pay back your loan, your lender will also take a close look at how well its assets will serve as collateral.
When you buy a business using financing, lenders typically want some assurance that they’ll be able to seize some assets to recover their losses if you ever default. That’s usually primarily going to be the business’s assets, such as its:
- Inventory
- Real estate
- Equipment
- Vehicles
However, they may also want a personal guarantee, which means that they can come after your personal assets as well. It’s easiest to avoid this when you buy a business that has a legal structure that protects you and sufficient assets to secure the loan.
Things You Can Do Before Applying for a Business Loan
Before you start applying for the best small business loans you can find, you should take steps to prepare yourself. It’s a massive transaction, and there are many moving parts. Here are some things you should do to get ready:
- Get a fair business valuation: The first step in financing a business purchase is establishing a fair value for it. You’ll need it to make a reasonable offer and your lender will need to review it during their underwriting.
- Negotiate the purchase: Not only will getting a good deal on your business acquisition save you money, but it will also increase your chances of getting a loan to finance it. Lenders want their loan-to-value ratios as low as possible to minimize risk, and reducing the purchase price is a great way to decrease it.
- Revise your tax planning: Acquiring a business has significant tax implications. Make sure you understand how it will affect your tax strategy, including the added opportunities and responsibilities it brings.
- Improve your credit: Having good personal and business credit scores are critical to getting the loan you need. Every lender will thoroughly review your credit profile before agreeing to finance your acquisition.
Purchasing a business is a significant undertaking and not something you should rush into or take lately. Prepare your finances and your credit well in advance, and strongly consider getting a good accountant to help you navigate the process.
If you need to build business credit or personal credit to improve your chances of qualifying for financing, consider a credit builder loan from Credit Strong. We use the loan proceeds to secure your loan, so there’s no credit check to apply.
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