It can be expensive to buy a business. Fortunately, there are lots of ways to take on financing your acquisition. In this article, you’ll learn how many business owners cover the costs of buying a business—and the operational costs that follow.
Important note: These practices may be suitable for people purchasing an entity that’s already in operation. Many of these methods can be used alone or with others. You may wish to speak with a local lender to help you decide on the right approach for your unique situation.
How can I raise enough cash for financing an acquisition?
There are lots of ways to find the cash you need to cover a business’s initial costs. Let’s dive into some of the most popular strategies:
Checking and savings accounts
Many owners use this pool of cash before considering any other cash sources. The reason? It’s the easiest to access and use. If you have cash available in these kinds of accounts, calculate what you’re willing to part with.
Need some help? Contact a banker who can guide you through these calculations.
Do you own stocks, bonds, or mutual funds in a taxable investment account? If so, you could use them in one of the following ways to cover your upfront costs:
By selling your securities, you could raise some or all the cash you need for your investment. Keep in mind that sales can result in mutual fund fees, broker commissions, and the realization of capital gains. Be sure to speak with a qualified investment professional before proceeding with this option.
Borrow against them.
You might also consider a portfolio loan (sometimes called a pledged asset line) to raise the cash you need. Through a portfolio loan, lenders use your investment savings as collateral and allow you to borrow up to 70 percent of the value of your accounts.
Because these loans are backed by collateral, they usually have low interest rates and are relatively easy to qualify for, provided you can meet the funding minimum your lender requires. You can learn more about portfolio loans in this article:
Again, be sure to speak with a banker before leveraging your securities. Your banker can explain the tax consequences you’d face by selling your securities and the risks of borrowing against them.
Personal lines of credit
Lines of credit are popular choices. With them, you can access a predetermined amount of cash to borrow and repay according to your lender’s terms. Many banks will allow you to set up a personal line of credit to use however you see fit, which can include covering the costs of acquiring a business.
This option involves some degree of risk. Failure to repay the funds you borrow could negatively impact your personal credit score. It can also keep you from attaining favorable terms on any loans you need to take out in the future.
If you’re interested in this form of funding, contact a local bank or credit union or work with an online lender.
Have you been contributing to a retirement savings account? If so, you could use those funds to cover some of your upfront expenses. There are several ways to access the funds in your retirement savings accounts, but keep in mind that any use of your retirement savings introduces risk, and in some cases, tax concerns.
Check out this guide for more information about using your retirement plan to cover the costs of a business acquisition:
Do you own a home or other properties? If so, you might borrow the difference between what you owe and what the property is worth. Many lenders offer home equity loans with favorable terms and minimal restrictions on how the funds can be used. The drawback is that these loans require you to put up your house as collateral. This means you could lose your home if you fail to repay a home equity loan.
Be sure to speak with a banker before considering this option.
Cash-out mortgage refinance
You may consider refinancing a mortgage you have on your home or another property to secure the funds you need. With a cash-out mortgage refinance, you can pocket the difference between what you owe on a property and 80 to 95% of the property’s full appraised value.
Rates and closing costs can be higher with this option than with a traditional refinance, so this option should be considered carefully before moving forward. Speak with a banker before considering a cash-out mortgage refinance to cover the costs of your acquisition.
You may also consider taking out a second mortgage on a property you own to cover some of your costs. Second mortgages are structured very similarly to a traditional home mortgage with clear repayment terms and interest requirements.
It can be difficult to find a lender who’s willing to provide this type of financing. Most banks view second mortgages as higher-risk investments of their money. Because of this, banks that offer them often charge higher interest rates than they might for a traditional home mortgage. You should speak with a banker before considering a second mortgage.
Some business sellers are willing to offer buyers a loan to finance part of the purchase. After verifying your credit and assessing your management and industry experience, the seller may agree to loan you part of the agreed-upon sales price in exchange for regular loan payments and interest.
Learn more about this option in this guide:
Many business owners apply for term loans to cover part of their acquisition costs. Term loans, which can be attained through a bank, credit union, or online lender, often have favorable terms and long repayment schedules. However, they can be difficult to qualify for, especially for borrowers with less-than-perfect credit.
To learn more about term loans and their qualifications, read this guide:
SBA loans are one of the most commonly used tools to cover the purchase of a business. Named after the Small Business Administration that guarantees them, these loans allow buyers to finance a large portion of their startup costs, working capital expenses, equipment needs, and building acquisition or improvements.
The SBA offers three kinds of 7(a) loans to small business owners to cover up to 90 percent of their startup costs, working capital, and equipment needs. They also offer 504 loans for the purchase of existing buildings, the purchase of land or land improvements, the construction of new facilities, the renovation of existing facilities, or the purchase of long-term machinery.
You can learn more about SBA loans and their requirements here:
Many lenders offer asset-backed loans to buyers who are willing to leverage their new business’s assets. Through these loans, you can finance your business’s inventory, machinery, non-mortgaged real estate, or other tangible assets to access fast funding.
Asset-backed loans are often easy to qualify for and attain, even for borrowers with less-than-perfect credit. To learn more about asset-backed financing, check out this guide:
Assume the business’s debt
If you’re buying a distressed business, this strategy may work for you. See if you can arrange a little-or-no cash-down purchase by agreeing to take on the business’s debt. Another option: Set up a deal that allows the seller to keep the business’s outstanding receivables.
To learn more about this option, read this guide:
Lease the business
Here’s an option few owners consider: a lease-to-buy setup that allows you to arrange for a future purchase after experiencing the business firsthand. If you choose this option, be sure to work with an attorney to set clear terms and conditions for the future sale.
For more information about leasing a business, check out this guide:
Rather than buying and leveraging the equipment your business needs to operate, you could lease large-ticket pieces of equipment. Many equipment wholesalers and distributors offer five-year leases. Some also offer the option to purchase the equipment at the end of the lease period.
You can learn more about this option in this guide:
Do you need a storefront or commercial site? If you plan to buy rather than lease property, you might consider a commercial mortgage. This form of loan can be used to purchase an owner-occupied office building, retail center, warehouse, or other commercial property.
Commercial mortgages differ from residential mortgages in both terms and the amortization period. Commercial mortgage terms often range from five to twenty years, and the amortization period extends past the term of the loan. Loans structured this way usually require a borrower to make monthly installment payments and a balloon payment at the end of the loan term.
These loans can require higher down payments than SBA-backed options, and they can be slightly more difficult to attain. Further, many lenders require borrowers to guarantee the loan, especially if the borrower is an individual or an entity with no borrowing history.
Learn more about commercial mortgages in our article, Small Business Financing 101: How Commercial Real Estate Loans Can Help You with Your #LocationGoals.
Commercial bridge loan
Bridge loans can be a good way to cover commercial real estate costs and other high-ticket items, including large batches of inventory, renovations, or repairs. These loans can often be attained quickly and relatively easily, even for borrowers with less-than-perfect credit. And, because the loans are collateralized, lenders tend to worry less about a borrower’s credit history and credit score. However, most will still require a credit check for loan approval.
To learn more about this option, check out this guide:
Commercial hard money loan
Some non-bank lenders offer commercial hard money loans that are secured by the borrower’s property. This short-term option allows business owners to purchase property quickly, with flexible terms, and often without checks to the borrower’s credit history. Keep in mind that the interest rate on these loans is usually high, so many borrowers view these loans as a last-resort option and refinance them into a mortgage at a later date.
Some online lenders offer hard money loans, but most small business owners turn to friends, family members, or local real estate investors to secure this form of funding. Be sure to evaluate the terms of a commercial hard money loan carefully before proceeding with this option.
Learn more about this option and other commercial real estate loans in our guide, Small Business Financing 101: How Commercial Real Estate Loans Can Help You with Your #Location Goals.
If you find you can’t raise enough cash through other means or you aren’t comfortable tapping into a significant portion of your savings or equity, consider bringing on a partner who can help you cover your initial costs.
Similar to the options above, there are risks and benefits to partnerships that should be considered carefully before proceeding. For more information about forming a partnership, check out this guide:
Important note: Before selecting any financing option for your acquisition, speak with a banker who can help you evaluate your choices, raise the cash you need, and minimize your risk exposure.
Will there be closing costs?
Often, yes. Closing costs for loans tend to run between 10-20% of the purchase price of the business. Plan to have this cash on hand to take ownership of your new venture.
What else should I know before financing an acquisition?
If you aren’t sure if the business’s cash flow will be strong at the outset, try to secure the capital you need for operations, not just the acquisition. There are a few ways to take this on. You could choose to fund an initial cash reserve from your savings accounts. Or, you might borrow against a business line of credit, which you can pay down when your cash flow improves. You can also consider invoice factoring, an approach that gives you access to cash by selling the financial rights to your invoices to others.
How should I proceed?
Work with a banker and decide which options make the most sense for you. Your banker can help you evaluate your choices and explain the documentation you need to secure financing for your new venture.
Would you like to connect with a bank and get set up with a banker? Click the Connect button below to get started:
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