Scenario 1: You’re a business owner ready to grow your company through acquisition. Your shareholders are willing to contribute more equity, and the business is cash-flowing well right now. However, the company you want to buy is going to cost you more than what you have raised, and you’re not sure you want to dilute your ownership stake further.
Scenario 2: You’re looking for a career change and want to buy your very first business of your own. You have significant savings set aside and a few potential investors, but will need additional funds to purchase your ideal business.
You are not alone. Because acquiring a business with all cash is unrealistic for most buyers, it’s important to understand what financing options are available and the pros and cons of each. Your choices include conventional bank loans, SBA loans, mezzanine debt, seller financing, equity from new investors and other sources. So, what type of financing is right for you?
Conventional Bank Loan (SENIOR/UNSUBORDINATED DEBT)
Securing a conventional bank loan can be difficult for small businesses and individual investors. Because banks offer lower interest rates than most other lenders, they have strict underwriting standards. Your personal and business credit ratings must be strong and consistent, you will need to put 20-30% down, and the business you plan to acquire must demonstrate steady profitability. Conventional business loans also require collateral equal to or exceeding your borrowings. If your company goes into default, the bank has the power to liquidate the collateralized assets.
Bank loans come in several forms, from traditional term loans to revolving and non-revolving lines of credit, delayed draw term loans and more. To fund an acquisition requiring a large sum of money at one time, you will likely apply for a term loan and repay that amount plus interest over a fixed period of time (the “term”).
Source(s): National, regional or local banks (the larger the bank, the lower the interest rate).
Typical Terms: 3% to 13% APR (Annual Percentage Rate). Monthly interest/principal payments for 1 to 5 years. 20% down. The stronger your credit scores (700+), history of business profitability and future business plans, the lower your interest rate will be.
Loan Amount: $5,000+ (into the millions if your credit is good).
Requirements: 650+ credit score. At least 2 years in business with several years of profitability in a low-risk industry (i.e. banks are less likely to loan to bars and restaurants). Clean financial history. To apply, you’ll need: personal and business tax returns, business financial statements, personal financial statement, customer list, bank statements, financial projections, personal and business credit scores, years in business, industry, business plan. For more on bank loans for businesses, read Fundera’s How Large of a Business Loan Can You Get?.
PROs: Low interest rates (typically 4-6%). Large loan size.
CONs: High personal/business credit required. Business assets used as collateral. Long application process (30 – 90 days).
Good for: Steady, proven companies in low-risk industries with strong credit history and reliable monthly cash flow.
Small Business Administration Loan
The U.S Small Business Administration (SBA) is a government agency supporting small businesses and entrepreneurs by guaranteeing a percentage of bank loans designated specifically for small businesses. The SBA does not directly lend you the funds – banks with an SBA program or special SBA lenders do – but the SBA guarantee allows lenders to provide loans to many businesses who may not get approved for conventional loans because of inherent business risk or lack of collateral. Since the SBA guarantees up to 85% of the loan, you don’t need as much collateral, making SBA loans a valuable option for service businesses without a lot of physical assets. SBA loans often offer smaller down payments and longer payment terms with interest rates only slightly higher than conventional loans.
Source(s): Banks with SBA loan programs, special SBA lenders. Check out Fundera’s top SBA lenders here.
Typical Terms: 6% to 10% APR. Monthly interest/principal payments for 5 to 25 years. 10-20% down.
Loan Amount: $5,000 to $5 million (cap).
Requirements: 680+ credit score. At least 2 years in business as a profitable, for-profit, U.S.-based small business (<500 employees and under $7.5M of revenue). Willingness of all shareholders with 20% or more ownership in the business to provide collateral and personal guarantees. No recent bankruptcies, foreclosures or tax liens. No defaults on debt obligations to the U.S. government (including student loans). Business debt service coverage ratio (DSCR) of 1.25x or more. For more on SBA qualifications, visit the SBA website or SBA7a.loans.
PROs: Less money down. Longer payment terms. Less collateral required than conventional bank loan.
CONs: Borrowing limit of $5 million. Higher interest rate (typically 7% to 9.5% for SBA 7(a) loans). Long application process (30 to 90 days).
Good for: Individual buyers seeking to buy their first business, or small, profitable asset-light businesses (less than 500 employees and under $7.5M in sales) more than two years old who don’t qualify for conventional term loans.
While traditional bank loans and SBA loans are the most common types of financing for small businesses, a few other excellent options exist. Next month’s blog post will cover mezzanine debt, seller financing and equity, and help you determine if one of these options is a better fit.