Securing a loan for a business acquisition can be more complicated and time-consuming than getting other types of loans. Lenders will want to evaluate not only your existing business (if you have one) but also the business you plan to purchase. You’ll likely have to document both businesses’ valuations, credit history, operating expenses, existing assets, cash flow, and more.
But taking the extra steps to get a business acquisition loan can be worthwhile even if you have cash on hand. Using a loan to buy an existing business can help you skip the startup stage and move right into established operations. Plus, an acquisition loan can help you purchase a higher-priced business that you can’t afford with cash alone, or it can provide a convenient way to buy out a partner in your current company.
Key Points
• Loans can help borrowers bypass the business startup stage, let them preserve cash, or put costlier purchases within reach.
• SBA loans, traditional bank loans, and seller financing are key loan types for acquiring businesses.
• SBA loans offer government backing, competitive rates, and long terms for repayment.
• Seller financing allows a buyer to pay the seller over time; note that it may call for a larger down payment.
• Loan applications require the borrower to submit credit scores, financial statements, a business plan, and a letter of intent.
Types of Loans for Business Acquisition
Numerous types of business loans are available to help you purchase a business. Each lender has its own borrower requirements and application process, but there are many similarities among them.
In general, even though they require more paperwork, business acquisition loans are easier to obtain than startup loans.
SBA Loans for Buying a Business
You can use an SBA 7(a) loan for a variety of purposes, including acquiring all or part of a business, securing equipment financing, or buying a business partner’s share of your existing company. Loan amounts max out at $5 million and terms can be as long as 25 years. They may require a minimum down payment of 10%.
You apply for SBA loans directly through private lenders, but because the funding is backed by the federal government, the SBA still has to approve your application. Working with one of the agency’s preferred lenders can expedite the process. This could be a good option to consider if you’re trying to buy a business within a tight timeline.
Traditional Bank Loans
Many banks will also operate outside the SBA’s 7(a) system to offer small business loans for an acquisition. Most will likely be packaged as traditional business loans.
However, you can also find specifically designed business acquisition loans. In these cases, lenders focus on the financial health of the target company. The application and approval process often requires additional due diligence.
Other options include a business line of credit, which may have a faster approval time. Another advantage of a business line of credit: Depending on the lender, credit limits can reach $500,000 or even more, providing more room for a business to expand.
Personal business loans also exist. However, they typically top out at $100,000, which may not be enough for you to buy the business you want.
Seller Financing Options
Another way to buy a business is with seller financing, a type of loan that doesn’t involve a formal lender. Instead, you generally make a down payment and then pay off the seller over time. Rather than receiving a lump sum, the seller gets regular payments on the debt, including both principal and interest. This can be a convenient method of buying out a business partner.
This kind of financing (also known as owner financing) may seem less formal, but it typically comes with a promissory note, a legally binding document that outlines the terms of the deal. With seller financing, the repayment term tends to be about seven years. You may also need a larger down payment of 30% or more, which is much higher than for SBA or bank loans.
The benefit is that it may be easier to qualify for seller financing than for a bank loan. You may also be more likely to receive information and support from the previous owner, since they have a financial interest in the business’s ongoing success.
Qualifying for a Business Acquisition Loan
When you’re figuring out how to get a loan to buy a business, bear in mind that every lender and type of financing will have different eligibility criteria. Still, there are some basic requirements you can expect no matter how you choose to fund your acquisition. Here are many of the documents you’re likely to need.
• Credit scores: Lenders typically review both your business and personal credit scores as part of the financing decision. Minimum personal credit scores vary by lender, but many set it between 650 and 690.
• Letter of intent: When you’re applying for a business loan to purchase a business, you may need to already be under contract with the seller. A signed letter of intent outlines the terms of the transaction. Just like when buying a home, you can include a clause that the deal is contingent to being approved for financing.
• Business and personal tax returns: You’ll very likely need to provide several years’ worth of tax filings for yourself and for the business you’re aiming to buy.
• Business financial statements: Expect to provide up to three years’ worth of documents for the company you’re buying, including profit and loss statements, balance sheets, and cash flow statements.
• Business plan: Outlining your plan for the business along with your management experience gives the lender more confidence that you’ll be able to successfully manage the newly acquired company.
• Debt service coverage ratio: This number compares the business’s net operating income versus its current debt obligations (including interest and leases). A higher ratio is better because it indicates there is more cash than debt.
• Down payment: Down payment requirements are usually reserved for seller financing and SBA loans. It can range anywhere between 10% and 30% of the loan amount and demonstrates to the lender that you’re financially invested in the business you plan to buy.
Preparing Your Loan Application
Given the many different types of loans to buy a business, plus alternative financing options to consider, the application process can be complex and even confusing. You can get started with a basic to-do list including these steps:
• Have an offer in place. Before you can qualify for financing, you’ll likely need your offer accepted by the seller with terms finalized in the letter of intent. That means you should have gone through the review and valuation process with the business to make sure you’re happy with the deal.
• Work with the seller. As you saw from the loan application requirements, you need quite a few financial documents from the seller. Ideally, you’ve already acquired those documents during the negotiation stage, but it’s still smart to maintain ongoing communication in case the lender requests additional statements.
• Know your credit scores. Checking your personal and business credit scores well ahead of your business purchase gives you more time to improve in case they’re lower than you expected. Plus, you can check for errors and get a rough sense of the interest rates you qualify for.
• Prepare your tax returns. You’ll need three years of tax returns when applying for a business acquisition loan. But you (or the company you’re buying) may also need to finish filing for the current year if you’re applying for a loan during tax season.
The Takeaway
Getting a loan to buy a business is likely to involve a few more steps than a general working capital loan. Whether you’re looking for an SBA loan, owner financing, or a traditional bank loan, you can take some actions in advance that could make the process smoother. For example, even before you apply, it’s prudent to pull together important financial documents and make sure your business plan is on point.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What types of loans are available for buying a business?
Loans you can use to buy a business include SBA 7(a) loans, traditional bank loans, and seller financing.
How do I qualify for a business acquisition loan?
To qualify for a business acquisition loan, you’ll need a letter of intent outlining the terms of the sale, financial statements from the business, a sound business plan outlining your ability to run the new business, and both personal and business credit scores, tax returns, and bank statements.
What documents do lenders require when applying for a loan to buy a business?
Lenders require an array of documents when you’re applying for a loan to buy a business. Among them will be a letter of intent, tax returns, profit and loss statements, cash flow statements, debt disclosures, and more.
What are the advantages of using an SBA loan to buy a business?
Using an SBA loan to buy a business may help you strike a deal with the seller since the loan is guaranteed by the U.S. government. Benefits to you also include competitive interest rates, the potential for large loan amounts, and longer periods for repayment.
How much down payment is typically required for a business acquisition loan?
The down payment you need depends on the type of business acquisition loan you get. SBA loans usually require a 10% minimum down payment, while seller financing may call for as much as 30%.
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