How to Get a Loan to Buy a Business

A business acquisition loan can be used to buy an existing small business or even a franchise. If you already run a business on a partnership basis, you can also use this loan to buy out your business partners. The right type of business acquisition loan, however, depends on your financial situation.

If you are an aspiring entrepreneur and want to buy an existing business, you may qualify for a startup loan. However, you would need to demonstrate that you have the necessary experience and resources to run the business.

If you are looking for a lower interest rate, you may want to consider an SBA (Small Business Association) loan. Depending on the lender and the size of the loan, the SBA loan process may take anywhere between 60 and 90 days.

Banks also offer business acquisition loans, but they also have strict requirements. Your credentials and the finances of the business will be scrutinized closely before the bank decides to give you a loan.

When money is tight, business owners often look for loan to keep their business operations running. Getting a business expansion loan is also easier if you are already running a profitable business and want to acquire another one of similar scope.

Ways to Finance Business Purchase

Buying an existing business has many benefits. In many cases, an existing business will already have reliable cash flow, experienced and knowledgeable employees, and an established customer base. Since an existing business already has a track record of success, financing the purchase of an existing business is often easier than financing a new business.

Here are a few ways to finance your purchase of an existing business:

Seller financing

A common way of acquiring funding to purchase an existing business is through seller financing, where the person selling you the business loans you money. It is usually an amortized loan where you need to make scheduled, periodic payments applicable to both the interest and principal. Such a loan pays off interest expense first, and then the rest of the amount is used towards reducing the principal amount.

Many business buyers like seller financing because the interest rate is often lower or the same as bank prime rates. It also keeps the seller having skin in the game. Banks consider seller financing as buyer equity, which means they may be willing to lend you additional money.

(For businesses offering this financial arrangement, see our listings of Businesses with Owner and Seller Financing For Sale.)

Bank loan

A bank loan is another option that you could explore to buy a small business. However, securing a bank loan from a commercial bank can be difficult. You need to have a great credit score and significant assets to have a bank loan sanctioned. Typically, a bank will give you a loan against your assets but not against your business plan.

SBA Loan

For buying a small business, an SBA loan is perhaps the best option. To be clear, the SBA does not give you a loan. Instead, it provides a guarantee to the banks on your behalf, who can then lend you the funds to acquire a small business. Of course, you will need to fulfill the qualifying criteria of the SBA.

Leveraged Buyout

A leveraged buyout refers to one company acquiring another company using a substantial amount of borrowed money to meet the acquisition cost. The purchasing company secures the debt with the assets of both companies as collateral. The company being acquired assumes the debt. Using this approach helps you maximize your returns while minimizing the cash investment. However, if things don’t go as planned, it can negatively impact your returns and increase your losses.

Assumption of Debt

This financing option requires you to not just buy a business’s assets but also its liabilities. In such transactions, the debt responsibility of the original payer is shifted to a new debtor under a fresh contract. The debt liability of the company being sold will also impact the purchasing price of the business. Usually, the buying company subtracts the debt value from the agreed sale price before making the payment.

How do you determine which is the right financing option for you? It will depend on how much you are willing to invest, and the amount of risk involved. If you have a great track record and an impressive credit score, you can always opt for an SBA loan to buy a small business.

Lender Considerations

If you are looking for a business loan, banks and financial lenders consider several aspects other than your credit score. They like to look at your complete financial profile before deciding on the interest rate and loan approval.

Here are a few things lenders review before approving business funding:

Credit history

Almost all lenders look at your credit history, your credit score, and your credit reports before they approve any business funding. Your credit history reflects how you have managed borrowed money in the past.

If your credit history is poor, it shows that there is a higher chance that you may default on the repayment. This may cause many lenders to back off because they are afraid that you may not repay the money that they lend you.

Paying your bills on time and ensuring that there are no errors on your credit report can help improve your credit score. Different lenders have different requirements when it comes to credit scores. For instance, for an SBA loan, you should have a credit score of 680 or more. For short-term financing, a credit score of 600 should suffice.

If your credit history is not that great, you may still manage to get a business loan. However, in such cases, the interest rate is usually higher than normal.

Income and expenses

If you have above-average income, lenders are less likely to look at you as a financial risk. Having a good income means that you would be able to pay your monthly obligations on time. Even if you have a high income, you may still not get a good interest rate if your expenses are also high.

Ideally, your debt-to-income ratio should be 43% or less if you want to secure a loan from a reputed lender. If your credit score is high, some lenders may allow a bit of flexibility. 

Cash flow

If your business has a low cash flow, lenders may consider you as a financial risk. When you have a low cash flow it may indicate that you will take care of your business costs and expenses first before repaying your loan.

Lenders may check the bank account statements for you as well as your business before they approve a loan. They look at your account statements to get a clear idea of the cash flow in your business.

Down payment

If you borrow less money from the lenders, the risk to the lender is also less. By putting down a large down payment, you can also manage to get a low interest rate on your loan amount.

If your credit score is not very good, you can increase your chances of getting a loan approved by putting in a sizeable down payment.

Value of your collateral

Collateral is an asset that you agree to give to the lender if you are unable to repay your loan. When there is collateral involved, it becomes a secured loan versus an unsecured loan.

The interest rate is much lower in the case of a secured loan. That is because the lender has a way to recover his money in the case of non-repayment.

Your collateral value also determines how much money you can borrow. However, be very careful when using your home or vehicle as collateral. If you are unable to make your loan payments, you may lose your home or car.

Liquid Assets

Usually, lenders like to see that you have sufficient income to pay back your loan amount. However, some lenders would also like to see assets that you could quickly convert to cash, such as savings, government bonds, or stocks.

Having such assets means that you have more than one way of repaying your loan. When you have adequate liquid assets to cover your loan amount, you are considered less of financial risk by lenders. You may even manage to get a lower interest rate.

Loan term

From a lender’s perspective, if you borrow money for a shorter period, your ability to repay the loan does not change much during this period. However, when you have a lengthy loan term, there are chances that your ability for repayment may be hampered or change.

Some people prefer to apply for a shorter loan term. The monthly payments may be higher when the term is shorter, but you also pay less interest over the period.

How to Improve Your Chances

With the right preparation, securing a business loan becomes easier. However, there are a few strategies that you can implement to boost your chances.

Develop a solid business plan

Some lenders may not ask for a business plan, but you should still include one when applying for a business loan. Having a solid business plan can make it easier for you to secure a business loan. Your business plan should be well-thought-out with an impressive executive summary that hooks the lenders.

A strong business plan shows that you are prepared, responsible, and organized. It also gives you an opportunity to show the lenders why you need the loan and how it will help you grow as an entrepreneur.

Your business plan should contain detailed information about what your company does, and the products and services you have to offer. You should also include details about market opportunities and a competitor analysis showing how your business has an advantage over them. Including your financial projections and a marketing plan to grow your business are also recommended.

Evaluate your credit rating

All banks and lenders perform a credit check before they even think about approving your loan application. They use your credit score to determine whether or not you are a potential risk, and should be given a loan. When you apply for a loan, lenders check your personal credit score as well as that of your business.

Sometimes there may be errors in your credit report which could significantly lower your credit score. Closely review your credit reports and if you see any errors, dispute them so that they are removed from your report.

Making timely payments on your bills and accounts can also help improve your credit score. If you lack a credit history, take some time to build your credit history before applying for a business acquisition loan.

Keep your books clean

Lenders review your financial records before they even consider approving your loan application. Current business owners should ensure that balance sheets, income and loss statements, and cash flow statements are complete and accurate before applying for a loan.

You should not only ensure that your books are clean but also have a CPA review them before submitting a business loan application. You may also submit financial statements audited by a CPA to increase your chances of getting a business loan. When you provide detailed financial documentation, it shows that you are financially responsible, and therefore, a suitable candidate for a business loan.

Improve your business health

If you are a business owner looking to expand your business to a new location, you should try to improve your credit score before applying for a loan. Your credit score may reflect your creditworthiness, but lenders still like to look at your overall business health before they approve your business loan. Sometimes, they may look at the health of your business for non-financial reasons as well. When you have a proper business format, an effective operations system in place, and innovative marketing and financial plans, it shows that you have the ability to make a business successful. It creates a positive impression about you and enhances your suitability for a business expansion loan.

Improve your revenue growth

Current business owners should try to improve their revenue growth before submitting a loan application. Most lenders would like to see at least a 10% increase in revenues year after year. That is because the idea of a business loan is to fund growth instead of filling out losses. Also, companies that have stable and consistent revenue growth are in a much better condition of paying off their business loan, making them less of a risk.

Offer some collateral

High-value collateral makes you less of a risk and improves your chances of getting a business loan approved. If you are willing to back your debt with personal assets, lenders may be more willing to sanction your loan.

There are two reasons for this. First, collateral secures a loan and lenders don’t need to go after your company in case things don’t go well. Second, when you pledge collateral, it makes lenders feel that you will be much more cautious with the borrowed money.

Approach multiple lenders

When applying for a business loan, don’t hesitate from approaching multiple lenders. Different lenders have different requirements and may offer different rates. Looking at multiple lenders may help you get a better deal. If more than one lender approves your loan application, evaluate their loan requirements and choose the one that suits your needs.

Conclusion

A business acquisition loan helps you reap the benefits of buying an established small business. Knowing what lenders look for in a loan applications, and how to improve your chances of getting a loan, can make securing a loan that fits your business goals a reality.