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Let’s TalkWhy should I get my business pre-qualified for financing?
Why do I need to get my business pre-qualified for financing when selling my business? Isn’t that the buyer’s responsibility?
Note: The information in this article applies only if the buyer of your business is likely to be an individual or small competitor. It does not apply if the likely buyer is a mid- to large-sized competitor, another company, or a financial buyer, such as a private equity group. These buyers often pay cash or put down up to 90% cash at [glossary-ignore]closing[/glossary-ignore].
Your business must get pre-qualified for financing because your business must produce enough cash flow to cover the monthly loan payments. Loans are pre-approved based on the cash flow available to support the debt service. The cash flow to repay the loan is generated from your business, so the pre-approval process is dependent on the cash flow generated from your business.
While the buyer has some burden of responsibility, the principal responsibility lies with you, the seller. Do not take the attitude that, “The buyer wants to buy my business, so it is their responsibility to find the money.” Remember, it is your business that is repaying the debt service. Most denials for financing are related to issues regarding the business, not the buyer.
If your business does receive pre-approval, we recommend that the buyer also get pre-approved as early in the process as possible. The lender will review the buyer’s financial position, credit, management experience, and several other criteria.
If both your business and the buyer have been pre-approved, you have a favorable chance of obtaining financing for the sale of your business.
Here’s an example:
Cash Flow
| Annual cash flow = | $300,000 |
| Less buyer’s salary | $200,000 |
| Annual cash flow after buyer’s salary = | $100,000 |
Price & Terms
| Asking price = | $1,000,000 |
| Down payment = | $200,000 |
| Amount financed = | $800,000 |
Debt Service
| Annual payment = | $109,008 (10-year term @ 6.5% interest) |
| Plus 25% debt coverage ratio (DCR) = | $27,252 |
| Annual payment + DCR = | $132,260 |
Cash Flow After Debt Service
| Annual cash flow after buyer’s salary = | $100,000 |
| Less annual payment + DCR = | $132,260 |
This business would not qualify because the “annual cash flow after buyer’s salary” of $100,000 is not enough to support the “annual payment” + “cushion” (debt coverage ratio) of $132,260.
When pre-approving your business for financing, the lender may also review additional criteria.
For example, if revenue has consistently declined in your business in recent years, your business may not be approved. Additionally, the lender will require an appraisal of your business. If the appraisal does not meet the lender’s requirements, they may deny your loan. In summary, there are several reasons your business may not be pre-approved for a loan.
If both your business and the buyer have been pre-approved, you know that a buyer has a high probability of obtaining financing to purchase your business.
If your business cannot get approved for financing, you have two options:
- Offer seller financing;
- Sell your business for all cash. However, you should reduce the purchase price to account for the fact that you are offering all cash.
Do not take the attitude that, “The buyer wants to buy my business, so it is their responsibility to find the money.” Remember, it is your business that is repaying the debt service. Most denials for financing are due to issues with the business, not the buyer.
