Buyer’s Personal Equity
In most small- and mid-sized business acquisitions, this is a key element. Anywhere from 20% to 70% of the capital needed to purchase a business comes from the buyer. The remainder is financed by the seller. Sellers typically offer terms of 2-10 years; however, the deal must make sense financially for both parties involved.
One of the simplest and best ways to finance the acquisition is to work closely with the seller and negotiate a seller note. The terms offered by sellers are usually more flexible and more agreeable to the buyer than those from a third party. Seller financing is also quicker to arrange and requires less paperwork than traditional financing sources. How does seller financing work? If the price of a business is $500,000 and the seller is offering 50% financing, then the new buyer would put down $250,000 and make payments on the remainder until the note is paid in full. Nearly 85% of small business purchases involve seller financing.
SBA financing offers buyers attractive loan terms and interest rates while eliminating, or reducing, the need for the seller to carry a note. This means a lower down payment and lower debt service for the buyer, which translates into more net income for the buyer. Both of these factors make SBA financing attractive. SBA financing can sometimes be combined with seller financing. Nearly 95% of small business loans for the acquisition of a small business are made through the Small Business Administration (SBA). This program is called the 7(a) Loan Program. The SBA does not actually loan money, but rather “guarantees” or “insures” these loans in the event of a default. This limits risk for banks offering these loans and encourages banks to lend money to small businesses. A small fee is involved when procuring a 7(a) loan which helps to support the program. Because this is a government-sponsored program, there are highly formal guidelines that any bank must follow when making one of these loans.
You can also avoid taking out a small business loan altogether and use your retirement funds to finance your new business. Even better, because you’ll be buying stock as an investment in your own company, you don’t have to take a taxable distribution. Contact us for complete details. Creative use of financing has allowed us to finance million dollar transactions with as little as $20,000 cash down. Qualifications – while numerous qualifications exist, plans should be fully accessible and should be enabled to be rolled over into another plan. Penalties – if done right, there are no penalties when using your 401(k) or IRA to buy a business.
Advantages of Financing the Purchase of a Business
- You can buy a bigger business with higher earnings.
- The seller receives cash at closing, which can increase your negotiating leverage. This does not apply to seller financing.
- The seller receives the tax benefits from an installment sale, which increases your negotiating leverage. This applies to seller financing only.
- Business pays off the debt from operating income.
- Interest on the debt is tax-deductible.
Other Forms of Financing
The forms of financing above likely comprise nearly 95% + of all forms of financing the acquisition of a small business. Other forms of financing exist; however, they have not been proven to be readily available and accessible. Please feel free to contact us if your situation is highly unique, and you believe you may have other forms of financing available for you.