Financing a business acquisition is very different than financing a home purchase. In a business acquisition, both the business’s and the buyer’s financials are scrutinized to make sure the deal makes sense. Because lenders loan based upon a borrower’s ability to repay the loan, the cash flow of the business is a critical element in the loan decision. If the business does not generate enough cash flow to service the loan and meet all of the Buyer’s personal lifestyle needs, the lender will most likely not fund the deal. As a result, sometimes even a money-making business cannot be financed because the potential borrower has personal needs that exceed the income generated by the business’s cash flow.

Lenders on real estate transactions typically lend based upon the value of the real estate. If a borrower defaults on a home loan, the lender can simply take the property back and sell it to cover their loan. Most business purchases, however, do not have significant assets, and it is common for the sale price for a business to exceed the value of its tangible assets by a significant margin (that difference, by the way, is called “Goodwill”). Because most lenders have no recourse against tangible assets if a borrower defaults on a business acquisition loan, lenders routinely look for additional collateral for their loans. The Buyer of a small business seeking a loan to make the business acquisition must be prepared to make a significant cash down payment and pledge personal collateral like a home in order to satisfy the needs of the lender.

For many years, before the emergence of significant lending activity by the Small Business Administration (SBA), Seller financing was the only choice available to Buyers and Sellers. And even today, there are many reasons why Seller financing might be the right choice for a Seller. Seller financing offers reduced paperwork and reduced approval times, and terms can be structured to fit a deal instead of adhering to the “one size fits all” terms offered by the SBA. Sellers can structure significant tax savings by deferring income into future years, and Buyers can feel good about the Seller’s confidence in them and in the business’ ability to service the debt. Sellers will, however, always require a personal guarantee from the Buyer and retain a security interest in all of the business property transferred. One drawback to Seller financing is that Sellers will typically require a much higher down payment and a shorter repayment time than other lenders. Sometimes Seller financing can be combined with other types of financing. When this occurs, however, Seller notes are usually subordinated to the other financing and Sellers are often reluctant to finance a large portion of the purchase when subordinated.

Many local, regional, and national banks and lenders offer business acquisition loans that are guaranteed by the Small Business Administration (SBA). If you are considering SBA financing, you should always look for a lender with SBA preferred status. This is your assurance that the lender routinely does these types of transactions and can readily obtain approval from the SBA for your loan. SBA loans are typically amortized over 10 years, and are priced at the prime rate plus a percentage. Currently, the maximum amount that a lender may charge is 2.75% over prime. SBA loans require many different fees including packaging fees, loan guarantee fees, appraisal fees and others. These fees can add up to 2-4% of the loan’s value; often these costs can be added back to the loan amount. Depending on the deal, down payments on SBA loans are between 10-30% of the transaction value. Most deals, however, fall into the 20-30% down payment range. SBA loans require personal guarantees, security interests in the assets, and real property collateral if the business assets do not provide adequate collateral. And while many SBA lenders state that they lend on cash flow and not assets, it has been our experience that few deals are strong enough to obtain finance without additional collateral.

Since SBA lenders typically require a borrower’s home as collateral, many business buyers have elected to simply draw equity from their homes. Home equity lines of credit are popular because they can be prepaid, involve little upfront costs and can typically be repaid over a longer period of time. Often buyers pull cash from their home to cover the entire purchase price or a very substantial portion of the price while asking the Seller to carry a small amount. Sellers are often willing to provide financing to a Buyer when that Seller loan is in first position.

In spite of what you may have heard, there are very few sources for business acquisition financing other than the three sources listed above. Business acquisition loans that are not SBA guaranteed or not backed by real property are nearly impossible to obtain. Buyers should be aware of anyone offering to help obtain highly leveraged financing with little or no down payment required from the borrower (Don’t bother attending a “Buy A Business With No Money Down” seminar; you’ll be wasting your money and time). Borrowers should also beware of any lender or loan broker that requires a large amount of up front or packaging fees.