This article provides a simple guide on how to go about getting a loan to buy a small business. We’ll cover your main funding options and show you how to find and then value a business as a going concern. And then to complete your picture, we’ll cover the key stages involved in making a business loan application.
Rollover for Business Startups (ROBS) is a less well known way to get a loan to buy a business. If you already have a career behind you, ROBS allows you to withdraw funds from your retirement plan to invest in your business without financial penalty. To learn more about this option, you can talk to a ROBS expert by reaching out to Guidant.
Getting a Loan to Buy a Small Business
You have a number of options open to you. We suggest you also consider the pros and cons of each option we covered in How to Fund a Small Business. Let’s take a look at how to get a loan to buy a business.
1. SBA Loans
With the exception of getting a loan to buy a business from a close friend or family member, an SBA (Small Business Administration) loan is the least expensive loan you are likely to find. This is because the SBA acts as a guarantor of your loan, which reduces the risk and hence the cost of your loan.
Typically an SBA loan costs 6-9% of the loan value per year. If the loan is over $150,000, you also have to pay of around 3-5% fee for the SBA to act as the guarantor.
So what’s the catch? The SBA set the bar high for getting a loan to buy a business so you have to fulfil the following main criteria:
- Possess a credit score of over 680
- Make a downpayment of 10-30% of the total sum required
- Pledge assets (e.g. personal or business real-estate) as collateral
- Demonstrate that the business leadership team has the experience required
- Prove the business you want to buy is in good financial shape
Note: The SBA prefer your down payment to be made from personal savings. However, they will except payment from another source, like the ones we list below.
2. Rollovers for Business Startups (ROBS)
A great way to fund buying a business (or the downpayment for an SBA loan) is to get a ROBS. This uses money from your 401(k), 403(b) or IRA to invest in your business without you incurring tax or any plan penalties for early withdrawal. This is because, it’s not a loan. Instead, your retirement saving plan becomes a shareholder in your business and receives dividends like you and any other shareholder.
If you want to learn more about, you can reach out to Guidant and speak to an experienced ROBS consultant.
3. Home Equity Loans
Another option open to you, is getting a loan to buy a small business secured by your home. Offering your home as collateral, reduces the bank’s risk considerably, but you still need a personal credit score of at least 620.
The reduced risk brings down the cost of the loan typically to around 3-5% per year. There are two main types of home equity loan:
- Home Equity Loan (HEL) – you raise a lump sum on your home and make monthly loan repayments
- Home Equity Line Of Credit (HELOC) – you secure an open line of credit, which works a bit like a business overdraft. You pay an agreed rate of interest for the money being borrowed at any given point in time.
4. Seller Financing Loan
Yes, it’s just want it says on the can. The business seller helps you to fund the purchase of their business. Business owners usually consider this when they find it challenging to find buyers able to raise sufficient funs to buy their business. Rather than not sell, they give you back 10-50% of the loan you require out of the proceeds of the sale.
The rate is usually competitive and in the region of 6-10% because they are as keen to sell as you are to buy. But remember, they will be likely to check you out carefully (including your personal credit score) to make sure their money is in safe hands.
5. Friends and Family
You may have friends and family prepared to loan you part of the money or because an investor in the business in return for shares. However, getting a business loan from close friends or family has its risks and I would only consider this if you would usually mix business and pleasure. This is because you could run the risk of your closest friends if things don’t go as well as expected.
How to Find a Business to Buy?
The fundamentals of finding a business can be turned into questions, which you need good answers to. Let’s take a run through the rights questions to ask.
What type of business is right for you?
Our advice is simple. Choose a business which you are passionate about because you’ll be committed to it potentially for years to come. It also makes a lot of sense to focus on business models and industries that make best use of your skills and experience. Being tempted to move outside of this is a big risk. It will also be much more difficult to get a business loan secured.
How well established should the business be?
The first thing to consider is how much you will be able to realistically raise. There is no point is looking at businesses you cannot get a business loan to buy. Beyond this, it makes sense to consider carefully where your skills are experience lie. Running a startup with a handful of staff is a very different proposition to managing a business with 50 staff in three different locations. It also requires different skills.
Where does the business need to be located?
A big consideration here is whether you are going to restrict your search to the area you live in or consider moving. If you are going to consider moving to another region, discuss this with your partner before investing too much time. Without your partner’s full support, it’s going to be hard to succeed.
If you are considering different locations, be sure to do your research. For instance, is the customer catchment growing or declining? How easy will it be to hire employees? What are the local business rates? If the conditions are not favorable for your business in any given location, cross the option off and look again.
How can you find relevant businesses for sale in this location?
The important thing, is to try and see as many of the relevant businesses for sale as possible. It’s also important not to be in too much of a hurry. Buying the wrong business and an inflated price is something anyone can do. You need to take you time and find the right business at the right price.
When you find it, be prepared to move fast to complete the deal. Below we’ve provided a list of places you could start looking. This is not exhaustive at all, be prepared to get creative to find a real gem.
- Search online trade publications for businesses for sale
- Look at the business section of local newspapers (maybe place a ‘Business Wanted’ ad?)
- Network at the local Chamber of Commerce
- Ask local accountants, lawyers and bank managers
- Speak to local commercial real estate agents If you put energy into your desk-research and then network pro-actively, you’ll discover a much broader range of businesses for sale.
Tip: The best business to buy is one that you can see real potential to improve. If it’s perfect already, the price will reflect this.
How can a business broker help?
After you have first explored yourself, contact the local business broker. They may be able to introduce you to businesses you have not been able to discover. Brokers tend to be retained by sellers to find a buyer. They tend to cost 5-10% of the business purchase price, but this fee can be negotiable. They earn their fee by helping you find the right business and helping you to complete due diligence, negotiate price and complete the deal.
Sense check: Startup or Buy an Existing Business?
Once you’ve explored how to get a loan to buy a business, discovered an existing business and placed your own value on it, you’re in a good position to compare buying a business with creating the same business from scratch.
To do this, you need to create an outline startup business plan. This will help you workout the costs, break even analysis, cash flow forecast and timescale involved to create the same business. If this is a lot less that the cost of buying the existing business in your sights, you should consider starting your own in more detail. If the cost would be similar or more, it makes more sense to buy an existing business. This is because there are big risks involved in building a business from scratch, especially if you have no previous experience of doing this. Take a look table below, which will give you a feel for some of the risks involved.
Creating a Startup vs. Buying a Business Summary Table
|Creating a Startup||Buying a Business|
|A lean startup can start trading for a fraction of the cost of buying an existing business||Purchasing a business is a much more expensive upfront cost than creating a startup|
|Until the business is profitable, all business costs need funding||The business is profitable, which means it can to some extent fund future business improvements|
|The brand will have to be conceived from scratch and promoted to build market awareness||The brand is established and known in the marketplace|
|No customers exit and there is risk involved in generating a customer base from scratch||The paying customer base is already well established and repeat business flows|
|The business may take years to reach break even before it becomes profitable||The business is profitable with a proven business model|
|Operational processes will have to be put in place and refined||Operational processes are in place and have already been refined to help the business run smoothly|
|Experienced employees will need to be recruited, which is not easy for a new business||An experienced team is already in place and everyone knows their role|
|Premises, equipment, etc. will have to be purchased from scratch||Tangible assets exist that have been valued as part of the cost of buying the business|
If you have no prior experience of running a business, we recommend starting small. This allows you to cut your teeth on a startup with putting big money on the line. Whereas if you have previous experience of running a business successfully, you’ll be well placed to take an established business to the next level.
Another way to assess this, is to create a forecast business plan for the business you are considering buying. Do you have a strong plan to grow the customer base, increase sales, reduce costs and improve profitability? If not, it’s not a business you should consider buying.
The Juice Press
This article has has helped you to understand how to go about getting a loan to buy a small business. We’ve also covered how to find a business for sale and compare it’s asking price with creating the same business yourself. We strongly recommend that you get advice from an experienced accountant and a lawyer once you have a business firmly in your sights.
As we mentioned earlier, ROBS is a less well know way to get a loan for your business. If you would like to understand this option better, we suggest talking to a ROBS expert by reaching out to Guidant.