In this article, we discuss the process of getting a loan to acquire a business. This article covers the basics of a business acquisition loan – what you need to have in place before you apply for a loan and how to get the process started.
This article helps you if:
- You are looking for a loan to buy a business
- The business you want to buy is in operation and profitable
- The business is valued at $700,000 at a minimum
For more information about other methods of financing a business purchase, read our article about financing business acquisitions.
Business acquisition loans are SBA-backed
Most commercial banks are reluctant to offer loans to people who want to buy a business unless the loan is guaranteed by the Small Business Administration (SBA). Because the SBA provides very solid guarantees, banks can reduce their risk and receive an incentive to make otherwise “risky” loans.
However, the SBA guarantee is considered a last resort as far as collections are concerned. Banks have to ensure that the loan can be paid by the business or the borrower. Banks are the first line of collections. The bank can collect on the SBA guarantee only if it’s not able to recover funds from the business or the owners’ personal assets.
As a result, you need to be ready for the bank’s underwriting process. This preparation gives you the highest chance of getting the funding you need.
Lastly, don’t worry if your situation isn’t “perfect”. The SBA is in the business of helping entrepreneurs who couldn’t get a loan otherwise.
Before you start looking for businesses
If you are serious about purchasing a business, you need to do a few things before you start the process. Obviously, you are reading this article because you plan to use financing. To improve your chances of getting that financing, consider the following:
1. Check your personal credit and the credit of all your potential partners.
Ideally, your credit scores should be at least 650. Obviously, higher credit scores are better. Lending institutions, including SBA-backed providers, use your credit as a proxy for financial responsibility. We know it is not always accurate (nor is it necessarily fair), but this is how they do it.
2. Determine your net worth – personal assets and personal liabilities
Lending institutions need to know the net worth of you and your partners. You need to show the lender your personal assets such stocks, savings, home equity, retirement savings, and such. Additionally, you need to show the lender your liabilities, such as your mortgage, car loans, and personal loans.
3. Gather the last three years of tax returns
The bank will also ask you and your partners (those with 20% or more ownership share) to provide your complete tax returns for the last three years. Since you don’t want your loan to be delayed, get your tax returns ahead of time. If you don’t have them, speak with a tax professional.
4. Start raising funds for the equity injection (“down payment”)
In most traditional SBA-guaranteed loans, the borrower is expected to provide 10% of the acquisition cost as an equity injection. This number can be reduced to 5% if you are also using seller financing and if the seller is willing to provide a two-year standstill.
This discussion often brings up the issue of so-called “no-money-down loans.” For all intents and purposes, these loans don’t exist. There are some very specific situations that can require minimal money down, such as some very asset-rich leveraged buyouts. However, most transactions require a 10% to 20% down payment. It’s best that you be prepared to pay this. For more information, read “Equity Injection Sources for an Acquisition Loan” and “How Much Money do you Need To Buy a Business?”
Starting the process
The most important thing you need before you can start seriously looking for financing is a signed Letter of Intent (LOI) from the seller. While you should certainly speak to some lenders before you get the letter, no one will give you a proposal unless you have the signed LOI.
Step 1: Select the provider you will work with
Your first step is to select the lending provider to work with. A number of providers offer SBA-guaranteed loans. While their requirements are similar, they also have differences. Select the loan that works for you and that you are comfortable with.
Step 2: Provide a full application
The next step is to provide a full application. This step can be relatively easy, or extremely hard, depending on how prepared you are. Ideally, you should have your personal financial reports, the financial reports of the business, your taxes, and other necessary reports ahead of time. Getting this information ahead of time saves you a lot of headaches and helps ensure you meet the deadlines defined in your letter of intent. You can find more detailed information on business acquisition loan requirements.
Step 3: Go through the underwriting process
The next step is for the lending institution to start its underwriting process. The length and depth of this process depend on the type of business that you are acquiring. The lender evaluates the assets and liabilities of you and any partners you may have. The lender considers your business experience and examines the financial records of the business. Finally, the lender orders an appraisal of all relevant assets and performs a thorough vetting of all important issues. If all goes well, your loan is approved and you are ready to move to the last step.
Step 4: Funding
The last step is funding the loan. In this step, the lender’s appointed escrow agent distributes funds, assets, and stock according to the agreements you have with the seller (an Asset Purchase Agreement or a Stock Purchase Agreement). After this step is completed, you formally own the business.
Want to finance a business acquisition?
The first step to work with us is to submit this form. Once we review it, one of our associates will contact you to discuss the specific details of your acquisition.
Given the complexity of how businesses can be purchased and the products that are used, this document is not guaranteed to be 100% accurate or cover every potential option. However, we make every effort to provide the best information. If you have comments, suggestions, or improvements, contact us via LinkedIn.