Whether you are a novice entrepreneur trying to finance your first purchase of a small business or an established entrepreneur looking to purchase a small business to expand your portfolio, you need money.
What options are available to obtain financing to fund this? A bank loan or your own savings? Asking a friend or applying for a line of credit? There are no rights and wrongs when it comes to getting the money to buy a small business.
Your choice will depend on your unique situation — the nature of the business, the size of the business, the various legal and regulatory requirements, etc. It’s important to note that it is often possible to combine funding sources in order to acquire a business. For example, an SBA loan is often combined with seller financing to cover the loan, while a certain amount of equity could be given up in order to cover the down payment. There are many combinations you can work with.
The first and easiest source of financing for your next business purchase is using your own money. You might have enough funds in your bank to buy the business. Having stock investments can also be a potential source of funding.
Many people think of mortgaging their homes, but this is not recommended. Remember, only invest the money that you can afford to lose.
Financing your purchase with cash is a rare practice and if you do this you will forgo the opportunity to further grow your investment through leveraging it. There is almost always a combination of equity financing and debt financing. You can fund the down payment from your personal funds and choose other ways to finance the remainder.
The Small Business Administration connects entrepreneurs with lenders and provides guarantees to the lenders instead of issuing the loan amount itself. This is without a doubt the most popular method of funding a small business acquisition and requires any Acquisition Entrepreneur to file an application for an SBA loan.
SBA loans are considered less risky loans for the banks; therefore, they offer lower rates to the applicants.
You can apply for SBA loans to fund your purchase, working capital requirement, or inventory purchases of the newly acquired business. To qualify for an SBA loan you must be acquiring a healthy, for-profit business and be putting in substantial owner equity, although there are a number of other requirements.
Ideally, you can combine your personal funds with SBA loans to put together the total amount required to buy the business. If you have a good credit score and at least two years in business, SBA loans are probably the best option for you.
Seller financing is a term that originally came from the real estate industry where the seller handles the mortgage instead of a financial institution. The idea has been replicated in the M&A industry. The buyer of the business gets funding from the seller instead of applying for a loan.
If you want to go for seller financing, be aware that such loans are issued at competitive interest rates. The advantages of seller financing include quick purchase and the option of tying the payment of the loan with business performance. If you’re also going for an SBA loan, however, be aware that the SBA puts limits on the type of seller financing and how long the seller can give advice to a new owner post-sale. Adding the option encourages the seller to disclose all the facts about the business.
Conventional bank loans will always be an option to consider. But they might not be feasible for most people. That’s because banks usually require substantial physical assets belonging to the company as collateral for the loan.
If you have some assets with the bank, they could give you a loan to fund your purchase. They’ll generally want a down payment of at least 30%. But there are additional requirements that might make this more difficult to obtain. For example, you need a great credit score and an SBA-backed guarantee.
This is an investment vehicle that is put together by business searchers who chose to use privately raised capital to search for, acquire, and grow privately held companies.
The leadership of a search fund – known as the search fund partners – will use the fund to pool private investors’ capital in order to fund the search and acquisition process. These often target smaller and midsized companies.
The process of setting up a search fund is relatively straightforward:
To launch a search fund, partners first need to raise enough capital to cover the overhead costs. They then conduct outreach to identify potential acquisition targets. Once they find a potential target they conduct their due diligence and, if they think it will make a good deal, enter into negotiations to acquire the business.
The ultimate goal of these funds is to increase the business value and eventually exit at a profit.
Crowdfunding and P2P lending is yet another financing method to fund your acquisition of a small business. Through crowdfunding and P2P lending, different third-party online intermediaries connect the lenders/investors with the business buyers. You can get equity-based crowdfunding or reward-based crowdfunding.
The intermediaries charge you a service fee for funding. P2P lending doesn’t necessarily have to be done through third parties. Instead, you can leverage your own network of interested investors to fund the purchase.
Some Acquisition Entrepreneurs are able to access equity funds, which can help fund the purchase of a business by providing a cash injection toward the down payment. Usually for as little as 20% of the down payment all the way to 80%.
So, if the down payment is 10% of the transaction and the other 90% comes from debt like an SBA loan, then the cash injection would be 2% to 8% of the total purchase price.
In return, the fund could receive 2.5 times that amount in equity, or 5% to 20%. In these cases, there would be a shareholders agreement to protect the rights of the minority shareholders, and possibly some preferred dividends.
Of course, the exact terms of an equity injection can change greatly depending on the lender.
There are numerous ways to leverage different financing options to make the purchase of the new business happen.
You should analyze which option of funding works best for you before you decide how to finance the acquisition. In many cases, you can combine financing sources in order to raise the total amount required.
At Dunes Advisors we are experts at analyzing and assisting with financing of all types of businesses.