You’re looking to finance the purchase of a small business. What do you do? Where do you start?
Let’s talk here about the most common ways to finance the purchase of a small business.
No-money-down opportunities are seldom realistic
For the purposes of this article, a small business is defined as one that costs less than $10 million. But before we go into detail about the ways to actually finance a business, let’s address a belief that is prevalent among buyers. That belief is that you can buy a business with no money down — by financing 100 percent of it.
While it may be technically possible to make such a purchase, it’s very rare.
Let me give you some perspective by asking you a few questions. Why would a seller provide 100 percent financing? That is like turning over the keys of the business to another person and hoping for the best. And from a bank or investor perspective, why lend money to a buyer who is not willing to risk their own money? Would you?
Six financing methods
Here are six financing methods to buy a business. Note that these methods are seldom used alone. Instead, an offer usually has a financing package that bundles a number of these methods. More detailed information is available here.
1. Your own money
The easiest way to finance a business purchase is to pay for it yourself. For this method, you use your own assets such as bank accounts, stock investments, mortgages against your home, and so on. As a rule of thumb, I never recommend that people get a loan against their home or cash-out their retirement money to pay for a business — especially if you have a family.
Most people seldom buy the business outright with their own funds. Instead, they use their own funds for the down payment — which also shows the bank that they are committed — and finance the rest.
2. Seller financing
In this case, the seller gives you a loan that is amortized over a number of years. Depending on the seller, this note can cover 30 percent to 60 percent of the selling price.
There are advantages to seller financing. It is relatively easy to get and it can be cost competitive. Additionally, it can be used to tie payments to the performance of the business. This strategy helps ensure the seller gives you accurate disclosures about the business.
3. SBA loans
Bank loans guaranteed by the U.S. Small Business Administration are commonly known as 7(a) loans and help individuals who need up to $5 million of financing to acquire a business. The application process can take a couple of months while the SBA participant bank performs its due diligence. You can learn more about the qualification requirements here.
