How to Finance a Business Purchase
It is important to understand the ways to finance a business purchase so you can determine the size of business you’re capable of buying. You should try to secure financing or at least get indicators from lenders before you start a serious business search.
Many buyers assume that they can finance buying a business with a small down payment, just as they do when purchasing property. But buying a business is different. There are no rules about the size of down payments, but it’s advisable to have at least 30 to 50% of the purchase price in cash
Some Business Financing Options
It can be very difficult to get a bank loan for all the money you will need to buy a business. Banks need collateral and many businesses do not have the tangible assets that translate into collateral.
Many business buyers turn to BDC for financing a business purchase, as they may be able to offer more liberal lending policies and flexible terms than a bank. For more information about BDC’s financing options, click here.
Seller / Vendor Financing
Seller financing is quite frequently used in business sales. Quite often, sellers will have to provide some financing in order to sell their businesses. This financing could be in the form of a traditional loan secured by collateral, or in the form of an earnout, where the financing is repaid from future cash flows from the business. Sellers will be reluctant to provide financing unless they believe you are capable of profitably running the business.
Mezzanine financing, or subordinated financing, is a loan that offers more flexible repayment terms than conventional financing. It is typically used when the business has little collateral but, because of this risk to the lender, it will carry a higher interest rate. It is called subordinated financing, or sub-debt, because it ranks below other secured debt in priority for repayment.
BDC can also be a good choice for mezzanine financing.
Loans From Family and Friends
If you are fortunate enough to have family members or friends with surplus cash, you may be able to approach them for a loan. Terms can vary depending upon the relationships and whether they have a profit motive or just want to help.
If the business you are planning to buy has outstanding potential, you may be able to attract investors who will take partial ownership of the company. Investors can be venture capital companies, or even friends or business associates. This is not an option, however, if you want to be the sole owner of the business.
Home Equity Loan
If you have a substantial amount of equity in your home, you may wish to borrow against it. This is often a poorer choice since you’re essentially using your own collateral instead of using the facilities and equipment of the business as collateral.
Need Financing? Prepare a Business Plan.
It’s a good idea to prepare a business plan if you’re planning to approach outside lenders or investors. While the business plan can’t be specific to a particular business because you haven’t found one yet, it can include your experience in the industry, ability to run the business, and plans to grow the business. Of course this means you have to know what kind of business you’re planning to buy.
If possible, avoid any financing that requires personal guarantees or uses personal assets as collateral. Your financing should be tied to the business, not to you.