There are pros and cons to starting a business from scratch or buying an established business -- and I can't say I favor one over the other -- but if you choose the latter, be especially cautious with your financing to avoid undue struggling that could linger for some time.
I recently spoke with a potential client who bought their business in April via a five-year seller's note. He had done all his homework and was convinced he was set for immediate and continuing success.
And then business slowed for no apparent reason.
That's unfortunate, but it happens. Few, if any, businesses avoid occasional hiccups. Even with the slowdown, the business is still well-positioned for future growth. There's no inherent weakness that has arisen.
So, what's the problem?
It turns out the payments he's making are killing him.
That's because he bought the business for five times earnings and financed it over five years, which is a common practice. Essentially, the entrepreneur will have no income over those five years -- and also will have to deal with the interest expense. Given the slowdown in business, no matter how temporary, this new business owner basically has to go into the hole every month.
Throw in the other expenses associated with the purchase of a business, such as legal counsel, surveyors and accountants, and the entrepreneur is cash strapped, to say the least.
Think About Long-Term Loans
Entrepreneurs often don't fully grasp the concept (and inherent value) of long-term loans. Think about a home mortgage. Without a 30-year term, it's safe to say that more than 90 percent of the public couldn't afford their current homes.
A longer-term repayment arrangement is your friend in this situation, even if you're paying more in the long run -- and you certainly don't need a 30-year loan for this transaction.
That is why securing an SBA 7(a) loan is such a smart idea. A little unknown fact, the SBA 7 (a) program will loan amounts of up to $5 million. Not only are the rates usually good, but you'll get 10 years to repay the loan.
Here's what you will need:
- a credit score in excess of 680
- a 10 to 20 percent down payment
- collateral, although the loan doesn't need to be fully collateralized
- lenders will also expect you to have three to five years of industry experience at a managerial level.
There is one caveat: You cannot use an SBA loan to refinance an acquisition note for at least two years.
Many entrepreneurs wrongly believe they are ineligible for SBA loans, and that's a shame. Some believe their business won't qualify. Others have been rejected in the past. Believe it or not, some aren't really aware of the SBA programs. Sad but true.
In any case, it can't hurt to at least try to secure SBA funding; I feel strongly that it should be your preferred option.