A business owner completes paperwork for a term loan.

Term Loans for a Business Acquisition

When it comes to funding a small business acquisition, loans are one of the most common sources of capital. Many commercial and community banks offer three kinds of loans you might consider for your acquisition: term loans, asset-backed loans, and SBA 7(a) business loans.

This article focuses on one of these kinds of loans: a term loan.

 

What is a term loan?

A traditional term loan is an arrangement you make with a lender to borrow a specified amount of money for a specific purpose for a set period of time. Your lender will set terms, and you will agree to repay the loan with fixed, equal payments and a preset rate of interest.

Term loans generally have favorable terms and long repayment schedules (up to 10 years), making them a great option for owners looking to cover part of their acquisition costs. They’re notoriously difficult to qualify for, but owners of businesses with an established credit history may find these loans a bit easier to attain. The reason: Banks will consider the combined earning power of the business being acquired and the buyer’s current business entity when making a lending decision.

If you’re unable to meet the qualifications of a traditional term loan, consider online term loans, which often have less stringent credit score and credit history requirements.

 

Keep in mind that online term loans usually have less favorable terms than loans offered by conventional lenders. These lenders often quote higher interest rates and offer significantly shorter repayment terms than traditional term loan lenders.

What qualifications will I need to meet?

To qualify for a term loan, you’ll need:

  • A strong personal credit score (generally 700 or higher)
  • A source of funding to cover a down payment, which may be up to 30% of your capital requirements
  • Verifiable management and industry experience

 

If you already own a business—and that business will play a role in the acquisition of your new business—you’ll need to demonstrate a few more qualifications:

  • A favorable business credit score
  • Good credit history
  • Positive cash flow that signifies your business’s ability to support the debt it’ll take on

 

How do I apply for a term loan?

Determine which commercial banks, community banks, and credit unions in your area offer term loans for business acquisition. Then, inquire about their rates and qualifications. If you qualify and are comfortable with the terms and interest rate a lender offers, you may opt to begin the application process.

Start by gathering the documents they request. Often, these will include:

  • Three years of personal bank statements, tax returns, and financial statements
  • Your business plan, which should describe how you’ll run the business and ensure its profitability

 

 

  • A statement that explains your management and industry experience
  • Verification of your ability to make a down payment
  • A copy of the business sale contract that proves your intention to acquire the business you’re financing
  • A third-party valuation of the business
  • A third-party valuation of the collateral you plan to put up or an audited copy of your balance sheet
  • Cash flow projections
  • Projected profits or losses
  • Balance sheet information for the business you are buying
  • Profit and loss statements for the business you are buying
  • A schedule of the term debt you—not the previous owner—have taken on for the business

 

If your current business will be involved in the acquisition, you may need to provide up to three years of business tax returns, bank statements, and financial statements and your business’s current debt schedule and repayment priorities.

If your loan request includes construction or leaseholder improvements, you’ll need to provide additional documentation, which may include a construction contract, a tax appraisal, and a third-party appraisal of the land or current property.

You’ll need an accountant and a valuation specialist to fulfill some of these requirements. You can connect with accountants, valuation specialists, and attorneys who will help you through the financing process and other early-stage goals through the Connect buttons below:

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What happens next?

Next, you’ll complete your lender’s application. You can speed through the remainder of the loan process and boost your chances of approval by completing the application in its entirety and by being responsive to your lender’s questions and requests for clarification.

You may choose to apply for term loans at multiple institutions to improve your odds of securing the capital you need.

Review the offers you receive carefully. Make sure you understand the terms, conditions, and risks of the loan (which may include losing any pledged collateral upon default) before signing any additional paperwork.

 

A quick note: Your lender may ask you to purchase creditor insurance, which provides assurance that the loan will be repaid in the event of your death or disability, but they're prohibited from making it a requirement. You can learn more about creditor insurance in our Small Business Financing 101 article, What Is Creditor Insurance?.

 

 

What should I do if my application is rejected?

Listen to your lending officer’s explanation, and ask for feedback on what you can do to position your request more favorably in the future.

Your lender may recommend simple tweaks to your business plan or a boost to your credit score to increase your odds of approval, or they may point to larger issues that you’ll need to resolve before reapplying for funding. You can make the necessary adjustments and submit a new application, or you can choose to apply with other traditional lenders or online term loan lenders who may be more lenient in their requirements.

 

Are small business terms loans right for me?

Like other forms of financing, term loans have advantages and disadvantages that you should consider carefully:

 

(+) A term loan may help you attain all the capital you need in a single transaction

 

(+) Term loans allow you to spread the cost of your acquisition over a longer period of time than you can through many other financing options.

 

(+) Term loans can help you build credit for your business, which is essential for attaining better financing options for future capital needs.

 

 

 

 

(-) Term loans can be difficult to attain.

 

(-) The loan process can be lengthy.

 

(-) Lenders may require collateral to secure your loan, which makes the downside of default even greater.

 

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Interested in other financing options? Learn about asset-backed financing, SBA 7(a) loans, seller financing, and other ways to attain the capital you need to purchase a business.

 

What's next?

After determining how you’ll finance your acquisition, you’ll have completed the steps that lead to closing on your new business. Read our guide, Close the Deal: The 10 Things You Need to Take Ownership of a Small Business, for advice on working through the final part of the acquisition process.

 

 

Looking for support through the acquisition process? We can help. Log into your owner’s portal for articles and advice that’ll set you up for success.

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