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What are the Best Sources of Financing for a Business Acquisition?

> Back to Key Questions

Suppose we help you find your dream business in Hawaii (and we will!), where do you get the money to buy it?

We should begin by saying that it is nearly impossible to buy a business with “no money down”, notwithstanding the fact you might (still?) be able to buy real estate on such terms. You need to have at least some money to successfully acquire a business, usually at least $50,000 to buy something respectable that we would represent, and ideally $100,000. Moreover, reputable intermediaryies will not help buyers to finance business purchases that are clearly beyond their resources.

That said, we can and will work with motivated buyers in a variety of creative ways to help you tap into all available resources to finance your dream business.

What are the most commonly used sources of acquisition financing?  They are summarized below, in roughly descending order of frequency.  Your VR agent can advise you on the applicability of these sources to your particular situation.  We’ll discuss some of the more critical sources in detail below.

Financing Source Frequency

Very Common Sources

• Cash equivalents (checking and savings accounts; money market funds, CDs)
• Stocks and bonds
• Gifts/ loans from friends and family
• Second mortgages and other real estate loans
• Seller financing
• Credit card financing

Moderately Common Sources

• SBA financing/ bank loans/ bank lines of credit
• Retirement accounts (IRAs, 401Ks, SEPS, pensions, etc.).  Many buyers are not aware that a small business is a perfectly legal and valid investment for most people in these accounts.
• Borrowing against a different existing business (lines of credit, accounts receivable factoring, inventory financing, equipment financing)
• Asset sales (real estate, autos, etc.)

Rare Sources

• Customer and supplier financing
• Angel financing
• Venture capital
• Small business investment companies
• Private placement
• Convertible debt financing

Friends & Family
This is a commonly used source.  If you plan to tap into this resource, we suggest having a frank, detailed discussion with them to work out precisely how much they are willing to invest, what the terms will be, what criteria the business will need to meet, etc. so that you can proceed with confidence and a clear understanding of their requirements.  Unfortunately, without such frank discussions, misunderstandings are all too common, and deals as well as friendships can suffer.

Retirement Accounts 
401Ks, IRAs and the like are being used more and more frequently to finance business acquisitions.  Advantages of this source:

• Guaranteed; no approval of bank or seller required
• No interest expense
• Returns on small business investment typically far exceed typical stock and bond returns

However, this source has one major downside: if the business fails, your retirement account will be depleted.

To use this source, there are some complex procedures and paperwork involved.  Fortunately, there are several companies that specialize in helping buyers tap into this source.  We are happy to provide referrals.

Seller Financing
While many sellers are reluctant to “carry paper”, we strongly encourage our seller clients to consider this option, and most do.  Many sellers have heard stories about buyers who “ran the business into the ground and didn’t pay” and are naturally reluctant. 

But if you have good credit, solid business experience, and a high level of integrity, most sellers will consider seller financing.  But don’t take it for granted.  You need to earn the seller’s trust and persuade him or her that you will take good care of the business and repay the loan.  In addition, it’s very helpful if you can develop a business plan at the same time you are conducting due diligence, so the seller understands your plans for the business.

Typical terms are 40-60% of the price financed, 7-9% interest, and paid monthly over 3-5 years on a fully amortized schedule.  Occasionally, the loan is amortized over a longer term with a balloon payment to pay off the note entirely around the 3rd or 5th year, under the assumption the buyer can get a bank loan to pay off the note by that time. 

The assets of the business serve as collateral, not your real estate.  However you will need to personally guarantee the debt, sign a promissory note and execute a “security agreement” that secures the business assets as collateral for the note and is recorded on public records.  Seller financing is sometimes used in combination with bank financing; e.g., 30% cash down, 50% bank financing, and 20% seller financing.

Bank Financing/ SBA Loans
Banks and SBA guaranteed/ insured loans are involved in only about 15-20% of business acquisitions.  While it is certainly a viable source for some buyers and some deals, sadly it is not for most.   Involving these parties also adds considerable time (typically 6-10 extra weeks) and uncertainty.  However, we have relationships with some of the most aggressive lenders in the country, and regularly close these deals so it is worth exploring.

To obtain bank financing, the following “perfect storm” of requirements must come together regarding the buyer, business and the deal:

Buyer

• Solid credit (e.g., 700+ FICO preferred)
• Management level or ownership experience in the business being acquired
• Must personally guarantee the loan and put up any real estate as collateral
• Cash reserves left over after the investment.
• Preferred that spouse provides another separate source of income

Business

• Strong and consistent earnings (generally $75,000+)
• Earnings verifiable on tax returns
• Not too dependent on current owner or any one customer, supplier, or employee
• Strongly preferred that business have hard assets (equipment or inventory) covering much of the value

Deal

• At least 20% down from buyer
• Price/ earnings ratio less than 3:1
• Monthly earnings/ note payment ratio less than 1.4, with sufficient earnings left over for buyer to maintain lifestyle
• Compelling, detailed and professional business plan prepared.

All banks are not created equal.  Some banks are much more likely than others to approve business acquisitions.  We can refer you to the best banks for your particular deal.