One of the fastest ways for entrepreneurs to get into or grow a business is to buy an established company. While it's possible to finance the purchase with cash or cash equivalents, very often at least part of the funding comes from debt. If you are contemplating applying for a loan to buy a business, it’s important to know how to position yourself and your business so that a lender will approve the loan and do so on favorable terms.
- What Lenders Look For
- How to Prepare for the Application Process
- Where to Find Business Acquisition Loans
What Lenders Look For
Banks, commercial lenders and other loan providers have one priority above all other considerations: They want to know that their loan will be repaid on time and in full. As a potential borrower, it’s your job to convince the lender you are creditworthy, and knowing how they form a judgment help you prepare effectively. Here are the qualities lenders seek when you’re applying for a business acquisition loan:
Experience: It's easier to buy a business if you are already running one, because the lender can directly review your company's performance. If you are not now a company owner, you need to point to relevant past experience running a company or managing a business even if you didn't own it. You can also impress a lender if you partner with someone who has demonstrated success in the relevant industry.
Planning: A lender will want to know how you plan to grow your company after the acquisition. There is little incentive to lend money if a business lacks apparent benefits. To that end, you must create a business plan that describes how new ownership will benefit the overall success of the acquired assets and, if applicable, how the target company will be folded into an existing business. The Small Business Administration (SBA) offers a handy online tool to build a business plan.
Financing: You must demonstrate that you possess the assets, reserves and collateral required to stay in business despite the inevitable fluctuations in profitability, all while continuing to repay your loan. The task has three components:
- New business owner: If you are not a business owner (and even if you are), lenders will evaluate your personal creditworthiness and access to funds. To that end, you'll want to clean up your personal credit before applying for a loan, which means reducing existing debt and demonstrating your ability to repay debt on time for at least a year.
- Existing business owner: You will be asked to provide the standard financial reports—balance sheet, income statement, cash flow statement—for your business. You should be able to show a successful record of operating profitably, controlling expenses and paying suppliers and vendors on time. Here too you can improve your chances for loan approval by reducing debt, eliminating waste and expanding revenues. You must also show how the new business will have a positive impact on your existing one and that you will generate sufficient cash flow to repay the loan.
- The target business: A lender will want to verify that you are not paying too much for the target business. It will evaluate the quality of the target's assets, its customer base and its liabilities. Good targets are companies that are not getting maximum returns on their assets, because better management of the asset should create new profit potential.
Business/industry type: Banks have learned that some businesses and industries perform well and are safer borrowers. These include professional service providers—attorneys, accountants, etc.—medical service providers, day care centers, mortuaries and partner buyouts. On the other hand, banks shy away from businesses with tight margins or vulnerability to shady dealings like restaurants, grocery stores, single-customer businesses, vice industries and product-related companies that are hard to explain.
How to Prepare for the Application Process
Banks have the most stringent application procedures. They require that you—and your existing business, if any—have good credit and have not been involved in bankruptcy, foreclosure, tax problems, garnishments, collections or late payments. To that end, banks and other lenders will check your credit history from the major credit bureaus. If you're a business owner, it will want to see your company's financial statements, tax returns, state registration, licenses, certifications, loan agreements and leases. Banks will need the same information from the target company. Banks usually take several weeks to close on a small business loan.
For an SBA-guaranteed loan, you will need to demonstrate that you are a for-profit enterprise, doing business in the U.S., in which you have invested substantial equity and that you have exhausted other financing options. SBA loans may take several months for approval. Online lenders usually require less documentation, and they frequently approve loans within a few business days.
At the closing for business loans, you’ll be required to sign a number of documents, including the loan agreement and liens on collateral. You may be asked to pledge personal assets as well as business ones. Any fees, down payments, tax prepayments and escrow deposits will be paid at the closing. You might have to sign contracts with the acquired company, agreeing to various understandings concerning the management of the new company, disposition of assets and liabilities, payments to existing owners and managers, personnel agreements and other items.
Where to Get Business Acquisition Loans
Banks and online commercial lenders account for a large share of the loan market for acquisitions. You can also tap into personal funds from sources like savings accounts, Rollovers as Business Startups (ROBS) plans, credit card advances, home equity loans and lines of credit, and loans from friends and family. The current business owner might be willing to accept stock in your company in lieu of some cash. An angel investor, venture capital partner, private equity company or business incubator might be willing to lend you money or invest equity into the business. You can also check into your options for crowdfunding.
Lastly, consider working a deal with the current owner, who many be willing to finance your purchase. In this arrangement, you pay some cash upfront and sign a note for the remainder of the purchase price. You use the cash flow from the acquired business to pay the note. The seller might be willing to take a minor equity position in return for furnishing you with consultancy services that can help you get maximum value from the consultancy, especially if you lack industry experience. For a detailed discussion on where to finance an acquisition loan, see this ValuePenguin article, "Best Business Acquisition Loans."