Buying a Business - Understanding Small Business Financing

As a business broker I am frequently discussing with clients and prospective buyers methods of small business financing. Once a buyer and seller agree on price and terms, it all boils down to due diligence and financing.

A lot of factors can determine how lenders will view your deal. It will depend on the type of lender, type of business, and what kind of assets does the business own that can be used as collateral. Is there real estate involved in the transaction?

A commercial banker or loan broker will show you what factors matter most and get your deal funded with their products.

Cash and Equity

Of course, if you're paying all cash, none of this is your concern, however 100% cash deals are not the norm.

Every business is unique and different, but one thing is certain before you seriously consider pursuing a business for sale: You or one of your partners will need sufficient liquid capital or equity for anyone to finance your deal.

Bank Financing

The stories of a "no money down" deals and 90% seller financing are rare and I have personally never seen one that was legitimate.

Again, depending on various factors, when acquiring small business financing through a commercial lender, there is a good chance you'll need 20-40% cash/equity down on the business, financing the balance with debt capital.

You will probably pay "prime + 2" in interest, meaning if the prime rate is 8%, your interest will probably pay 10%.

The term of the loan will probably be 5-10 years. Many of the commercial loans I've seen are 7 year terms.

Business with Real Estate

If you are acquiring real estate in addition to the business, many products are available as "Blended Loans". These loans are "blended" with the standard "real estate loan" (10% down, 30 years).

You end up with roughly a 15% down payment, and a term of 18 - 22 years, which is great for keeping your debt service down and increasing your Cash Flow.

On the other hand, 15% of business and real estate can still be a sizable down payment.

The cost on the "blended loan" will likely be more favorable as well with the real estate as collateral.

Seller Financing

Most small and mid size companies will involve a portion of seller financing.

It is appropriate to amortize the financing over a period of time and have a balloon after 2 or 3 years.

This way the financing serves two purposes: Funds the deal and shows that the seller has confidence in the business - and the buyer.