If you’re new to the process of buying or selling a main street business, you may not know how challenging it can be to involve outside financing in a deal. I keep being reminded of this by certain new buyer inquiries I receive on some of my listings of businesses for sale. I once had a buyer with less than $20,000 of available cash for down payment who was inquiring about a business with a $3.5 million purchase price. She was assuming she could simply walk into any old bank and get a conventional loan to finance the purchase.
Fortunately for the sake of our economy, her assumption was not accurate. Lenders are very selective when it comes to loans for business acquisitions, especially those that do not include any real estate. To help matters, the Small Business Administration (www.sba.gov) created the 7(a) loan program where the federal government guarantees up to 75% of the loan principal (85% if less than $150k), thus reducing but not eliminating the risk that a lender takes when issuing the loan. The SBA will guarantee a maximum of $3.5 million which implies a $5 million loan as the highest possible amount a buyer could expect to receive. There are several requirements and guidelines set by the SBA related to who is eligible or not eligible. These change periodically so it’s best to consult their website or an experienced SBA-approved lender.
Two Pieces to the SBA Loan Puzzle. Lenders will look at two things in terms of determining whether to extend a loan on a business acquisition – 1) the buyer’s background and financials, and 2) the past performance of the business to be acquired. Generally speaking, the buyer must have an acceptable credit rating and at least 20% of the purchase price available in cash for down payment. If short of the 20%, seller financing can be used to make up the difference. Again, speaking in general terms, lenders like to see 3 years of past performance from the business in terms of enough positive cash flow to support the loan and debt coverage going forward. If you’re considering starting a new franchise territory, the SBA has preapproved certain franchises which can make the lending process that much easier. Some franchisors have loan programs of their own not related to SBA. Lenders vary in terms of their risk tolerance, so you may see some lenders only look at the past 12 months and if other factors line up then they will move forward with the loan process. As in any major decision, it’s good to speak to a few qualified lenders to get varying ideas within a competitive environment to obtain your best solution.
Seller Financing. Most owners cringe at the mere mention of these two words, but in today’s market the large majority of main street deals include some level of seller financing. Cash buyers rock, but they are few and far between. Along with the tightening of the lending environment discussed previously, suffice to say that the only way to get a deal done may come down to having the owner become the bank. Granted there is risk in not getting all the proceeds up front, but there are also advantages to it as well. First off, the pool of buyers is greatly increased thus increasing the odds of a successful sale. Many buyers also like the fact that the seller still has some “skin in the game” and will continue to honor/support any non-competes or consulting agreements. Secondly, the note is paid with interest (5-7% typical) so the seller in the end collects more than the purchase price. Thirdly, tax deferment may lead to advantages especially in larger transactions (seek a qualified CPA or tax attorney for advice).
3rd Party Financing. There are non-bank lenders out there that will issue loans for business acquisitions. Typically these are at higher-than-SBA-lender rates and the terms may be more challenging as well. But if all else fails it may be worth checking into.
In summary, using outside financing to purchase a business can help a buyer acquire a much larger business than they would otherwise, which may be a more stable business with a larger free cash flow to the owner. From a seller’s perspective, having the business pre-approved for SBA loan and/or offering seller financing are good ways to increase the buyer pool for your business and increase the chances of a successful transaction.