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You don't have to start at square one to become an entrepreneur. Buying an existing business offers you the opportunity to work for yourself without all the challenges and risks of a startup.
This head start comes at a cost, however. And if your personal savings don't cover the cost of your purchase, chances are you'll be looking to apply for a business loan. Depending on a range of factors, you may be able to get a loan to buy an existing business, but first you'll have to size up your needs and requirements, prepare the right information and documents, and shop for the right lender.
What Do Lenders Consider When You Apply for a Business Loan?
When you're buying an existing business, lenders want to know about both you and the business you want to buy. That's fair: Up to this point, you and your prospective business have had two entirely independent histories.
As they would with any loan, lenders want to know about your personal credit history. Do you have a history of successfully managing debt? Do you handle credit responsibly? They'll want information about your income, your current business (if you have one) and any relevant experience that makes you a good candidate for running this new business successfully. Here's a short list of items to prepare:
- Personal credit score
- Tax returns
- Income documentation and/or cash flow statement
- Outstanding debt
If you already own a business and are looking to acquire another to expand operations or change your business model, lenders will also want to know about the financial health of your existing company. Check with your lender for a full list of financial information they require, but be prepared to provide the following:
- Financial statement (showing income, balance sheet, profit margin and cash flow)
- Business tax returns
- Business bank statements
- Business credit score
Further, they'll want to make sure your business strategy is sound and that your proposed business purchase has the income potential to allow you to repay your loan. Proving that could require showing:
- Valuation of the business you're acquiring
- Business licenses
- Three to five years of financial projections
- Business plan
Things to Do Before Applying for a Business Loan
Before you can apply for a loan, you need to assemble some basic information. Many of the answers you need will require input from the seller. Although this may seem cumbersome, it's also an opportunity to get some cold, hard facts about the business you're hoping to buy.
The Small Business Administration (SBA) recommends working with an accountant and an attorney to help you navigate the sales process. Together, they can help you accomplish key objectives, such as:
- Working out a fair business valuation.
- Negotiating and executing a letter of intent and sales agreement.
- Understanding the tax requirements and consequences.
To prepare for the loan application process, ask yourself:
- How much of the purchase price can I finance myself—and how much can I use as a down payment? Most lenders require at least 10% down. It's often preferable, and you may be required, to put down more than that since the more money you put down on a loan, the less money you will need to borrow.
- Do I have collateral I can use to secure my loan? Business loan collateral might include the business you're purchasing, equipment, vehicles, real estate, inventory and accounts receivable. Personal assets—such as vehicles, valuables, retirement accounts or your home—may also be used to secure a business loan, but beware of pledging an asset you wouldn't want to part with if the business falters.
- How does my credit measure up? Check your personal credit score for free and access a credit score and report for your proposed business before starting the application process so you know what to expect.
Where Can You Get a Business Loan?
Business loans are available from a variety of sources. Your current bank or credit union (or the one your prospective business uses) is an obvious starting point, but you can also shop around for small business lenders. Online lending platforms like Fundera connect small business borrowers with multiple lending sources for a range of business loans including Small Business Administration (SBA) loans, business lines of credit and term loans. According to Fundera's website, borrowers with at least $150,000 in annual revenues, one or more years in business and credit scores of 600 and above have been successful in securing loans.
For many small business owners, SBA loans work where other lending options do not. The SBA doesn't make loans to small businesses; instead, it guarantees loans from lenders like banks and credit unions, which takes some of the risk out of lending. As a result, SBA loans typically have favorable interest rates, but also have specific criteria borrowers must meet to qualify. Look over the SBA's 7(a) Loan Application Checklist to learn more.
Some alternative lenders also offer small business financing and may offer business loans to entrepreneurs who have at least $50,000 in sales, have been in business for 12 months or more, have no bankruptcies or tax liens and own at least 20% of their business.
Additional Ways to Finance Buying a Business
Getting a loan to fund a business purchase isn't your only option. If you can't find a willing lender or your approved loan amount doesn't cover the cost of the business, consider these alternative funding ideas:
Negotiate seller financing. Although some sellers are looking to cash out and never look back, some may be open to being paid over time. You can negotiate this type of financing into your sales agreement and skip the bank altogether.
Borrow from friends and family. This is not an option to be taken lightly: The emotional cost of defaulting on your loved ones is astronomical. But if you're confident in your ability to repay and are willing to write up an ironclad loan agreement, this can be a viable funding source.
Seek out investors or partners. You can share the investment—and the equity in your business. Just be aware that doing so will affect how you operate your business, who's in control and how profits are distributed.
Use your personal funds. In addition to your regular savings, you can consider using investments and other sources of cash to help pay for your new business. Just be wary of tax consequences and the risk of depleting your emergency fund or nest egg: Even the best business opportunity represents some risk. You can also take your reserves of personal credit into account, although financing large sums of money at high credit card interest rates isn't an ideal way to fund your business as it can easily cause your credit utilization to shoot up, which could have big credit implications.
If you're hoping to purchase a business with a minimal upfront investment—sometimes described as a leveraged buyout—you might try a combination of these options. For example, you might use personal funds to make a 10% down payment, secure an SBA loan for 50% of the purchase price and ask the seller to finance the remaining 40%. A leveraged buyout can help you get into a business you don't have the funds or borrowing power to buy outright. But the high debt load can also increase your risk, so proceed with caution.
A Lender's Perspective Can Bring Clarity
Seeking a loan to buy an existing business can be a lot of work, but it may have a hidden benefit. It requires you to formulate the value of the business you want to buy and your reasons for believing you can succeed. You'll need to examine the business's past financial wins—and losses—and map out how you can make money and grow in the future. Putting yourself through a loan application process can help you understand your investment more clearly. You may even get feedback on the risks and highlights of the opportunity you're considering. On an investment this big, clarity may be even more valuable than cash.