You’ll usually use SBA loans when you’re starting or growing your business. You might be starting from scratch, opening a new location, or adding on to your current location, but you could also use an SBA loan to buy another business? That type of expansion comes with a slew of benefits for your business.
Buying a business is one of the best uses for the SBA 7(a) loan program. It’s a stable and affordable strategy to enter a new market, buy out a partner, or expand your business.
Learn why the SBA 7(a) loan program is a great option for a business acquisition loan, and what to expect when applying.
How to prepare for a business acquisition loan
If you’ve applied for a business loan before, then you know that your lender needs to know the ins and outs of you and your business before making a decision. You’ll find that’s the case for business acquisition loans too, but your lender will also need to review the acquisition deal.
When lenders evaluate a potential business acquisition deal, they want to know about:
- the health of the business you’re buying
- your financial situation
- your industry experience
The business you’re buying needs to have a healthy balance sheet. That means that the business shows a history of managing debts well, and maintains a balance between retaining profits and paying them to the business owners. Of course, your lender will also need to make sure that your business can afford the new debt.
In a business acquisition loan, the combined funds of the loan and the equity you put in will pay out the departing owner that you’re replacing. Because the business will be carrying this new debt moving forward, it needs to have a history of profitability high enough to cover the monthly debt payments.
Another important factor to consider is whether your business will have any interruptions without the departing owner. For some businesses, there will be a “transition period” where the former owner slowly shifts their responsibilities to others. For others, the transition period might be more involved and include rethinking how you’ll do business going forward. Maybe you need to rename or rebrand the business or develop a strategy for continuing the former owner’s customer relationships.
Your lender will also look at your personal finances. If your business isn’t able to repay the loan, you’ll be the lender’s secondary source of repayment. If you’re considering applying for a business acquisition loan, do a quick assessment of your personal finances to review your:
- Net worth: How do your assets compare to your debt? Think about any investments, real estate, personal property, credit card debt, student loan debt, and mortgages you might have. Having “positive” net worth is a big first step in qualifying for business acquisition financing.
- Outside income: Do you make any passive income? Do you have another job that provides a stable income to you? Having outside income means the business won’t have to pay you quite as much and you’ll have more money available to make your loan payments.
Appraisals and down payments for business acquisition loans
Just like when you buy a home, buying a business requires an appraisal and a down payment.
If the business acquisition loan is more than $250,000, then your lender will hire a third-party business valuation service to estimate the business’s value. You’ll be responsible for the cost of this service. If the loan is less than $250,000 then your lender will do their own business valuation.
Make sure you’re prepared for this step of the process. The appraisal will determine the true value of the business and will impact your down payment amount. Additionally, your lender can only lend against the appraised value of the business.
If the seller is asking for more than the appraised value, you’ll need to pay that difference through another down payment. The additional down payment won’t be counted as equity towards the business acquisition. Instead, it’s seen as paying a premium for the business.
The minimum down payment on any business acquisition is 10% for the SBA loan program. Looking at an example, if you’re buying a business for $100,000, then you can expect to make a down payment of $10,000 and finance $90,000 through an SBA loan. Of course, your lender may require a higher down payment depending on the strengths and weaknesses of your specific request.
A seller’s note can be an alternative to your down payment
If you’ve done the math on your SBA business acquisition loan and can’t afford the down payment, another option is a seller’s note. This is when some of the acquisition cost is paid off slowly over time instead of as a lump sum.
A seller’s note can be used to fund this premium or it can count as a portion of the required equity. It can also be an effective way to manage the “transition” of an exiting partner as it ties their compensation to how well they handle their exit from the business.
Make sure to seek expert help when acquiring a business
Your SBA lender will do their due diligence on the acquisition on their part, but you need to have your own representation. This means an accountant, lawyer, or valuation expert who can provide another set of eyes on how the deal is shaping up. With the right help in place, your business acquisition is more likely to be successful.
Many businesses have used an SBA 7(a) loan from Pursuit to buy a business and expand their ventures. We’ve worked with businesses to find the right financing for nearly any business need, and we can help yours too! Reach out to Pursuit today to learn more about what’s possible.
