This guide details what you need to know about sources of financing, getting pre-qualified, negotiating the price of the business you want to buy, and more.
As strange as it might sound, you should be working to secure your lines of financing before you've even finalized your short list of potential acquisitions, let alone agree upon a price. But wait, you ask, where is the money to finance the deal going to come from? Most folks, many of whom might have turned to things like a home equity loan in the past to finance their acquisitions, figure they can't land the necessary financing these days given the collapse of the housing market and the tightening of the credit market.
Some of these naysayers are correct, says Mike West, managing partner of NorthShore Capital Advisors, a business advisory firm based in Knoxville, Tennessee. The biggest strike against potential borrowers is if their skills don't translate well towards running the business they want to buy. "Anyone expecting to land a loan by walking into their local commercial bank hoping to secure a government-backed small business loan better be ready to sell their skills as an entrepreneur," West says.
The pages that follow detail what you need to know about sources of financing, getting pre-qualified, what you need in terms of collateral and negotiating the price of the business you want to buy.
Sources of Financing
Types of Funding
When buying a business, there are primarily two different sources of financing you can pursue.
Debt financing: To go into debt means to borrow money from an outside source -- most often a bank -- with an agreement to repay the loan principle and usually a certain agreed-upon rate of return, or interest. You can also arrange for private debt financing from friends or family, in the form of loans. Many banks have been reluctant to provide long-term loans to small businesses, and that's why the Small Business Administration offers guarantees to encourage banks to make longer terms loans by lowering their risk.
Equity financing: Instead of taking out loans, you can in essence agree to sell stock or shares of your business to outside investors, sometimes venture capitalists. This is different than a loan in that you don't have to focus on repaying the debt, but you are giving up partial ownership and, in some cases, control.
Getting Pre-qualified for a Loan
Getting pre-qualified for financing often means going to a bank or other lender and obtaining a letter of pre-qualification for a loan. In order to get pre-qualified, you often need to provide information on the business you want to purchase, your collateral, and how you'll be able to repay the loan. Here are some pointers to keep in mind when getting pre-qualified:
Bringing Collateral to the Table
When thinking about landing financing, also consider what you will bring to the table as collateral -- something that might need to be as high as 50 to 70 percent of the selling price for any kind of debt financing, says Art Concha, senior vice president of Americas United Bank, a commercial lender in Los Angeles. Collateral can include any of the following:
Seller Financing Is a Possibility
Given how important the assets of a business are, the best financing game in town these days is obtaining your financing directly from the seller, says Andy Louis-Charles, head of Landist Capital Management, an investment firm in Raleigh, North Carolina. This basically means the seller is typically willing to wait from three to five years to be paid off. It's an option that has both its benefits and its drawbacks.
Drawbacks: On the downside, seller financing can add anywhere from 5 to 25 percent to the asking price because seller's will typically lend at higher rates than a bank would. However, not all sellers have the ability to wait for their payday.
Benefits: At the same time, since the seller continues to have some skin in the game, the buyer is obtaining a degree of security that the seller continues to have an incentive in having the business perform well and grow. Borrowing from the seller also creates more negotiating opportunities for the buyer than they would ordinarily have with say, a bank. You might be able to stretch out your payments to something like 10 years to keep your payments smaller or you could even offer the seller equity in the business, where they would begin to recoup their selling price through the continued profitability of the business.
Other Sources of Financing
These days, given the economy, Tom Burke, senior vice president of SBA lending at Wells Fargo, the nation's largest lender of SBA-backed loans, says he's surprised his bank isn't getting more calls from prospective buyers. "We have a lot of money to lend, but we're seeing some reticence on the part of borrowers," he says. "This is the time people should be looking for government-backed loans."
Here are three tips on how to land an SBA loan of your own:
Negotiating the Price
While you pursue your financing, you and the seller obviously need to come to a mutually agreeable price if you want to move forward and purchase a business. If you've become stuck, your accountant can lend you a hand by helping you understand how much you can actually afford to pay for the business after you account for your debt service and working capital requirements. Here are several factors to keep in mind:
DARREN DAHL is a contributing editor at Inc. Magazine, which he has written for since 2004. He also works as a collaborative writer and editor and has partnered with several high-profile authors. Dahl lives in Asheville, NC.