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Financing the purchase


 

Using 401k or IRA to buy a business

Question: Can a person use 401k assets or IRA self-directed assets to purchase a business, without tax implications? I am looking to purchase a business, and I found a company that is offering to use my 401K and IRA funds to set up the company. It sounds like a good deal. Do you have any information on this type of business?

Answer:
There are a number of programs available now that offer this type of scenario. Personally, I have not used this route, but if the programs work as fluidly as they are presented to be, this can be a tremendous option. You absolutely must have your attorney and accountant review any such deal.

Apparently and allegedly the tax code allows you to transfer money out of a qualified retirement plan to purchase stock in your own business. Since no "rollover" takes place, there is no taxable event. Once again, I must stress that you have this verified by a professional.

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Financing for a small online business

Question:
I'm interested in buying a small but profitable online business. I would need to get an SBA loan to finance the purchase. The problem is that the business has only been in operation for about 9 months. Also, being an online business, it doesn't have any tangible assets. Do you think I will be able to get an SBA loan given these factors?

Answer:
Pardon my bluntness: No way! Sorry. The SBA 7(a) loan guarantee program includes specific financial requirements that the business must meet which this business does not satisfy. Most specifically, they require at least two years of tax returns to verify the financials. Insofar as assets are concerned, this is less of a worry as these loan programs require personal assets (i.e. home equity, marketable securities, real estate, etc) to guarantee the loan. In any event, the SBA is not the way to go on this deal.

However, this does not mean that the deal can't be done. Any seller of a 9-month-old business has to understand that they will be required to provide financing for the deal or offer a significant discount for an all-cash purchase. If this particular seller is not flexible in his/her terms, then chances are they will not sell the business, or they may sell to a very uninformed buyer.

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Overview of seller financing

Question:
Can you explain how Seller Financing is typically handled in a deal? I'm in negotiations to buy a business now, and I want to make sure this is included -- but I'm not sure how much to ask for or what terms.

Answer:
You raise a very good point. While there are no set rules regarding seller financing as a percentage of a deal, one thing is clear: it's a critical component to any deal. First, it serves to validate all of the representations and claims that a seller may make about the viability of his/her business. Second, it's far easier to arrange seller financing than it is to obtain bank or SBA-backed financing. Third, it's an accepted practice. Lastly, it will allow you to leverage your cash down payment.

Having said this, my recommendation is that you target your offer to include 40-60% of the deal as seller financing. In today's market, the interest rate should be around 8%. More important than the rate is the amortization schedule. The longer you can negotiate to payoff the loan, the easier it will be on the business. As such, you're better off to give in to a higher rate, in exchange for a lengthier period. As a barometer, 5-7 years should be your target, at least in the initial offer.

Here are some of the additional terms you may want to offer:

  • Retain the right to payoff the loan early without penalty.
  • Make lump-sum payments towards the principal once per year.
  • There should be no payments for the first 90 days after closing.
  • The first year should be principal payments only.

As a last point, after you own the business for a while, if you have excess cash, you may want to consider offering the seller a discounted price to pay off the entire loan. In this case, you should get at least a 20% discount on any outstanding balance. If the business is doing well, call the seller and offer to pay off the whole note. Chances are you'll hear them starting their car during the conversation.

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Need financing but the seller has not reported all income

Question:
The actual owner is not reporting the exact amount of money that the business produces. How can I convince the SBA to give me the loan? Our credit is perfect and we own two houses.

Answer:
Thank you for your inquiry. First, let me clarify one thing: the SBA does not lend money. Rather, they guarantee a certain percentage on loans that traditional lenders may make for small business acquisitions. That being said, there are two fundamental aspects to the requirements of an SBA loan. First, the business itself must qualify. Second, the buyer must qualify from a credit, experience, and guarantee standpoint.

It sounds like you may meet the requirements; however, the business may not. For the business to qualify, the lenders use a formula based upon the prior two to three years of tax returns, reducing the Seller's Discretionary Cash Flow by an adequate wage amount for the new owner. Then they calculate the debt service to be certain the business can afford the payments. If this seller has not been reporting the total revenue, the business may not have enough demonstrative proof of being able to service the debt. If that is the case, you should pursue a seller-financed deal. Notwithstanding this, it's well worth you meeting with a "Preferred" SBA lender to discuss the deal. At the very least, it will show the seller the challenge that every buyer will face who does not have more liquid cash to use as a down payment.

This situation is a perfect example of how business owners quite often only fool themselves by not maintaining clean books and records. Generally, any undisclosed income pales in comparison to what they would get when they sell the business if they had handled all transactions legitimately.

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Can I qualify for an SBA loan with a bankruptcy?

Question:
I have a question about SBA qualifying: 3 years ago I sold a very successful post-production business. The sale was due to a horrific partnership. The buyers bankrupted the business and I never got released from my largest debt, which was about $700,000. In the end I had to claim bankruptcy. What are my chances of getting an SBA loan for another business and what will it take for me to convince them that I can do it again?

Answer:
I'm sorry to hear about your past experience and I won't spend any time discussing what you could have done differently; I'm sure you've beat yourself up enough already and I have the world of admiration for you for dusting yourself off and not being deterred. You are a true entrepreneur and you will succeed! I wish I had good news for you with potential lenders. From my experience, a bankruptcy will all but nullify your qualifying for any type of SBA or traditional bank-type loan.

However, this should not preclude you from being able to acquire a business. Your best option, without question (and one I always recommend even if you have flawless credit) is to negotiate seller financing. It may not be available in every case. It may require you to search a little longer, but I promise you that these deals are done everyday and in the vast majority of cases. In fact, without trying to sound like an infomercial, over 90% of our clients negotiate seller financing. This is undoubtedly the tact I would take in your situation. Get back into business. Negotiate the best deal possible. Build your business again and improve your credit. Once you do, the lenders will be banging down your door, but then again, you may never even need them!

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Alternative financing sources

Question:
I have owned and operated a Domino's franchise for five and a half years and now I have found an under-priced pizza restaurant in Hawaii. The problem is, due to certain events, I obtained a lot of bad marks on my credit report, which was great five years ago or I would not have gotten a loan then. I have never been late on an SBA payment or to the bank. How can I get the needed $50,000 start-up capital? The owner has agreed to finance another $20,000.

Answer:
You have a number of options available to you, but first I need to understand if you have any available capital. You have to approach this deal with the realization that you do not have a lot of leverage financially. The only factor in your favor is that the business is being sold at a discounted price. Therefore, you must prepare a proper presentation to potential lenders that outlines this facet very clearly.

For purposes of this answer, I shall assume not. The most logical place for you to go first is the bank that financed your Domino's business. They are the ones with a history on you. Second, should that fail, is to approach anyone or institution with whom you've had a successful financial relationship. Next, any possible personal friends/family members who you could bring on as a silent partner?

Should you exhaust all of these avenues without any luck, then the seller in Hawaii is your only resource. Since this business is under-priced to begin with, you should approach him/her with two deal scenarios:

  • To buy part of the business now with an agreed upon buyout over the next 2-3 years at a pre-determined formula, thus lowering the amount you need upfront.
  • Pay them more than their asking price but have them hold a larger note. If the business is priced below what you believe it should be, then you should have no problem paying them more if they're willing to finance more.

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Seller financing

Question:
I am looking at buying a business where the seller is offering 30% owner financing.  How is this typically structured?  What are the standard variables and negotiating points?

Answer:
While seller financing is something you always want in a deal, I would suggest that you shoot for at least 40%. Although deals vary, the note should generally be for five years, at around 8% with the ability to prepay at any time. I would also recommend:

  • Starting the payments 60-90 days after closing with no interest penalty for this period.
  • Have the ability to pay down the principal sums at least twice per year.
  • The loan is to be secured by the assets of the business and no personal collateral (i.e. your house). While you will have to sign personally, do not pledge any personal assets. After all, if the business is as good as the seller has most likely represented it to be, then he/she should have no problem securing his note against these assets.

As a side bar, if the business proceeds well in the future and you can afford it, approach the seller and offer to pay off the note immediately for a sizeable discount (at least 20%).

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Using house as a collateral for bank loan

Question:
I am purchasing a business with a successful 10 year track record. Purchase price is $2.8M with seller financing of $1.175M.  I have found a bank who will loan $975K, but they want my house as collateral.  The business has assets (no real estate) of approx $1.5M (600K inventory + 900K FF&E). While I intend to go forward, I was wondering about the potential benefits of refinancing with someone who would not require my house as security. When could you do this and with whom (SBA)?

Answer:
Unfortunately, when it comes to bank financing, they want bulletproof collateral and not the business' assets. Under normal circumstances I would strongly urge you to avoid pledging your house, but this case is a bit different. If I understand the deal correctly, you'll be completing a $2,800,000 acquisition for just 23% of your cash down at closing (the $650k difference between the seller financing and the bank). This is a very attractive deal. While it would be ideal to negotiate this transaction without any personal assets on the line, relative to the purchase price your collateral is not significant. But, the question remains whether there is another way. Some of the "hard money" lenders (those who charge a higher rate) may be willing to do this type of deal. Also, you may want to consider structuring the deal so that they provide you with a line of credit against the inventory portion which is collateralized by the inventory itself and use these funds towards the purchase price.

Also, you may want to contact some lenders and financial groups such as GE Capital who may be willing to buy the FF&E from you and lease it back. Here again you can use the proceeds to fund the purchase. In order to do this in a timely manner, you may need to get the traditional loan, secure it with your home, and have an option for early payment with no penalty and then explore the other options available to you.

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Bad credit, no money and no experience

Question:
Hi I have really bad credit and no money at all to invest. Do you think I will be qualified to open a small business? Also, I don't have any experience.

Answer:
I am a firm believer that anyone who has a burning desire to be in their own business can do so successfully. However, I don't want to give you any blind or unrealistic advice. The chances of you buying a strong-performing existing business are slim because it does take money. Perhaps, it may make sense for you to start up a small venture to, at the very least, get a flavor for what's involved day-to-day in operating a business. The entire key to your success at this point is education. You have the ambition, but simply lack the "know how".

If I were in your position, I would consider dedicating a year or two to acquiring the business skills needed. You may want to look to get a job temporarily where you can work alongside an entrepreneur and absorb as much as humanly possible. Having said this, you should also know that operating a business successfully is not the most difficult thing in the world. Personally, I think keeping a boss happy is a lot harder.

Above all, do not give up. When I began on my own in 1990, I had no money (actually I owed $60,000), and I did not go to a fancy college. In fact, I didn't even go to college. But, I was ready to do whatever had to be done to be successful. This included taking night courses, devouring every business book I could find, associating myself with winners, and getting up everyday with one goal: do better than I did the day before! I hate to sound like a wild-eyed motivational speaker but the results are there. Since then, I've bought ten businesses and sold nine and have been successful beyond my wildest expectations. I guarantee that it can be done.

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The pros and cons of SBA loans

Question:
Can you provide an outline on SBA loans and advise the pros and cons of it?

Answer:
By the time you read this, the SBA may have changed the rules! While the SBA has some attractive features, here are a few key pointers:

  • The SBA does not lend money. It guarantees loans for small business acquisitions (7a loans) that are then underwritten by traditional banks.
  • Fees are high. I was recently involved in a transaction whereby the loan amount was $1.33 million and the fees to the buyer were over $40,000, but, the SBA will lend you the money to pay these (isn't that nice of them?).
  • The maximum loan amounts vary depending upon budgets. As of today the maximum is $2,500,000 including real estate. Government fiscal budgets end September 30th every year and programs get shut down as the date approaches. Sometimes they'll alter the program (or even shut it down temporarily) during the year, so get your paperwork in quickly.
  • Use a "preferred SBA lender" bank. They can process and pre-qualify the loan in-house.
  • The business itself must qualify based upon 2-3 years of tax returns. The lender will generally take the worst year and calculate the total cash flow. Then, they will deduct a reasonable salary for you the owner. The remainder is subject to a formula (usually divided by 1.2) to determine the remaining cash flow to see if it can service the debt load.
  • You'll have to demonstrate to the lender that your background is suited to run the business. Prior failures were directly attributable to the buyer not having the right experience and so they are far more rigid on this aspect now.
  • You will have to guarantee the loan. SBA lenders are required to go after all available personal assets from the buyer as collateral; however, you can get away with about 40%. Yes, they will require your house if you have more than 25% equity.

On the plus side, you can achieve tremendous leverage as the SBA will lend up to 80% (you put up 20%; although they're now looking at 70%/ 20% from the buyer and 10% from the seller), they have ten-year terms, plus they'll also finance any real estate in the deal and blend it with the business acquisition loan for a very favorable term.
 

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SBA loans - Will my experience qualify for a loan?

Question:
I have worked in the childcare industry for many years. I am now interested in purchasing a day-care center. I have found a center I wish to purchase in another state. Because of my 25 years of managing day-care centers, will SBA look favorably in trying to obtain a loan with me as a semi-absentee owner?

Answer:
Excellent question! The SBA requirements have become far more rigid in the past few years regarding the borrower’s prior experience to be certain they have the background to operate the business. In fact, a senior executive at an SBA-preferred bank told me that an SBA audit two years ago determined that a lack of relative experience by borrowers was the single biggest factor in bad loans. Since then they have tightened up their requirements and rightfully so.

In your case, there is no doubt that your past experience is an excellent fit for the type of business you are looking to pursue. However, there may be concern if you do not intend to be the full-time operator. This is something that you will want to discuss with the individual lender as their specific criteria may vary. Personally, I think you are far better off to operate the business full-time for at least the first 6 months and then consider hiring a manager.

As you probably know, the SBA does not lend money. They simply guarantee a portion of the loan made by lending institutions. While there are specific SBA criteria, so too will each lender have its requirements. That’s why you may need to approach a few different SBA lenders. On this point, try to work with a “Preferred SBA lender”, as they can process your loan quicker and more efficiently.

If you’d like to learn more about the SBA’s 7(a) program, here’s a link to their Website page: http://www.sba.gov - earch for "7a loans".

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Combining seller and SBA financing - Getting the seller to agree

Question:
I have a business financing question. Let's say I want to buy a business that has a sales price of $230,000. The seller is offering seller financing of $130,000. All I need is a $100,000 down payment. My question is can I get a SBA loan requiring 30% down for the $100,0000 down payment (thus requiring a $30k down payment versus $100,000 down payment)? Or would the seller have a problem with this since he would in effect be the "second lien holder"?

Answer:
A lot depends upon the individual seller. In many cases where an SBA-backed loan is involved, the seller also participates in a percentage of the financing and clearly understands that they are in second position. However; in these cases, the seller is usually on the line for only about 10 – 20% of the total purchase. In the case you cite, the seller will be on the hook for 56% with zero security. If you are putting down $30,000 for a $230,000 purchase price, it may not meet the SBA guidelines either as borrowers under their 7(a) program are generally required to contribute 20% down payment.

I think this may be the bigger issue. As well, the SBA backed loans require specific personal guarantees and collateral between the business and the borrower. While I think the terms with the seller may be flexible, you won’t have the same wide parameters with the SBA program.

Although there are some very attractive components to an SBA deal, such as interest rate and term, the downside is regarding the personal collateral they require. With a seller loan, while you will sign personally, their lien is against the assets of the business. In your situation, I would certainly recommend discussing this with an SBA-Preferred lender; however, if you have ample capital, you may wish to negotiate a bit more with the seller.

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Spouse Is nervous - Putting up the house as collateral

Question:
My wife is flipping out that we are going to have to put up the house to finance the business, but isn't there a way for me to buy a business without risking my home? I really don't think I have the stomach for it.

Answer:
I don't blame your wife! Except for very rare circumstances you should not have to pledge your home to acquire a business. Of course, if you go the route of traditional bank financing (SBA or other), yes, you will have to collateralize the loan with assets outside the business. That is why it's so important to negotiate seller financing as part of the deal. First of all, seller financing goes a long way to validate the business, and his/her belief that you can run it.

Next, seller financing is a very normal part of small business transactions. 91% of my clients negotiate seller financing. Plus, a seller should/must accept the business' assets as collateral. After all, they've usually spent considerable time selling you on how wonderful these assets are...right?

Now, you must also realize that you will have to sign personally, and you must be prepared to accept that condition, but no hard personal assets pledged. With seller financing you will have to personally guarantee the loan via a promissory note; however, the seller's first lien will be against the business itself and then you. Rarely does it ever materialize that a seller comes after the buyer.

Often-times, buyers tell me they don't feel they should have to personally guarantee the seller note (obviously if you can negotiate around this, that's great, but rare) but I disagree for three reasons: a true entrepreneur is always prepared to put it on the line and bet on themselves to succeed. Second, if you're not 100% convinced that the business is right for you, and will grow substantially with you as the owner, then in addition to your concern about a personal guarantee, you should also think about whether you should pursue the business at all. Lastly, the seller needs to have some protection. It's only reasonable. Wouldn't you, if you were in their shoes?

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When seller financing goes bad – What happens?

Question:
I was wondering if, in one of your newsletters, you can address more detail on seller financing. More specifically, what typically happens if the new owner is late on payments or stops payments? Most sellers would not like to take the business back, and I would assume most buyers do not want to put up personal collateral. If there are tangible assets the business has, could the seller use that as collateral without being responsible for the lease of the business? In general, how does this play out when things go bad?

Answer:
This is an excellent question and I'm surprised that it has not been brought up earlier. In a nutshell, it isn't pretty when seller financing, or any financing for that matter, "goes bad". Let's keep in mind that in most seller notes the business assets are the security. While these notes are generally signed for personally by the buyer, they usually do not have personal assets pledged. Plus, the fact is, should it get to the point where the buyer isn't paying the seller, it's unlikely that they (the buyer) have any assets at all to cover the loan regardless of having signed personally.

Typically, a buyer and seller will have a note between them specifying the remedies and cures for a breach in payment. Generally, if the seller does not receive their regularly scheduled payment within a certain number of days after it's due, they are required to notify the buyer that they are in breach, and the buyer has a set number of days to cure it. If not, the remedies per the contract will be triggered.

If the buyer simply cannot pay the loan, and the note is secured by the business assets, then yes, the seller can take the business back. Unfortunately, the business is usually not in anywhere near the shape it was in prior to being sold. It usually resembles a house that has been in disrepair for quite some time. Nevertheless, this is generally the mechanics of what transpires. Regarding the lease, unless the original seller has remained on the lease as a guarantor when it was sold, they are no longer responsible and they can, in fact, take possession of the business assets and either sell them or run the business. However, should they choose the latter, and require a location to operate the business, then they may have to take over the lease as well. Now, it can get complicated if, for example, the buyer has been paying the note, but not the rent. If there was no lien filed against the assets the landlord may have taken possession of the property.

Often in a note of this nature, there will be a subordination agreement between the lender (the seller) and the landlord that provides for a mechanism for the lender (seller) to take over the business in the location without the landlord's interference so long as the seller pays any back and future rent.

As you can see, when deals go bad there can be lots of moving parts, and rarely is the outcome good for any of the stakeholders.

Having said all of this, the good news is that, with seller financing, if a buyer runs into difficulty and is upfront with the seller, most of the time the big "plate of spaghetti" outlined herein can be avoided. Sellers almost never want the business back. Buyers don't want to lose it. With both parties having exposure, the situation can usually be worked out either by the seller providing a brief holiday from payments, or some other concession to reduce the cash flow crunch that may be the catalyst of the problem. Also, if the buyer is open with the seller and makes them aware of the situation (hopefully before it starts to deteriorate) the seller may even be willing to spend time with the buyer trying to address and repair the business difficulties. After all, unless the buyer has run the business into the ground, who better to provide counsel to the buyer than the prior owner?

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Determining how much business you can afford

Question:
I am interested in buying a business that is for sale for $2 million, with annual earnings of $500k. I am planning to use $500k in home equity for the purchase, but the seller is not willing to offer financing. What are my odds of being able to come up with financing for the $1.5 million balance? I'm told the SBA is my best option.

Answer:
Although I do not know many of the additional details regarding this business, it is likely that your best option will be an SBA loan through a traditional lender. While the SBA itself does not make loans, they guarantee up to 75% of a loan that a traditional lender will make under the SBA's 7(a) program. The maximum loan amount can change periodically so get updated information.

As I'm sure you can appreciate, there are numerous conditions attached to SBA loans and some points to note about them which are as follows (see also the SBA Website: http://www.sba.gov)

  1. The business must demonstrate that it can support the debt based upon prior year's tax returns.
  2. The buyer's required down payment can vary, but generally is around 20%.
  3. Recently, a number of SBA deals I have been involved with require the seller to participate in the financing as well for around 10% and be in second position to the bank.
  4. The SBA wants to have as much security as possible for the loan through a combination of the business' and your personal assets.
  5. Loan fees are quite steep; however, the SBA will finance them over the term of the loan (how nice!). Nevertheless, the fees are generally meaningless relative to getting the financing and completing the acquisition

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Financing a business purchase with little capital

Question:
I have very little in the way of capital, other than home equity, to invest in a small business. I want to buy a small business, but don't want to use home equity, which will be used later to partially finance my kids' college education. What other sources of financing are available and which is the best?

Answer:
Unfortunately, buying a business is not like the "no money down" real estate infomercials you see on TV. You will need to fund the down payment at the very least. Your best option will be seller financing and, in the best-case scenario, this can be around 50% of the purchase price. Surely there are cases where the seller may finance more, but it's rare. I fully understand your desire to not leverage any of your assets and I'm definitely not an advocate of being reckless. But, if you're not willing to leverage your assets such as your house on a business that you believe that you can grow, then chances are that the particular business, or business ownership itself, may not be for you.

Buying a small business requires some risk. Clearly, with the right information you can dramatically reduce the risk and eliminate the guesswork. But, entrepreneurship requires you to bet on yourself. You need a burning desire to succeed, and a belief in yourself to do so. You'll find that the most successful entrepreneurs have all put it on the line at some point to be where they are today.

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Financing a small restaurant/café purchase

Question:
I have been searching for about 6 months for a business. I have looked at some delis, cafes, and restaurants, but have found that banks do not want to finance these types of businesses. Some of these businesses are long-standing and reputable. Why is it so hard to find financing? What type of businesses do banks like to finance?

Answer:
Banks do a wonderful job of promoting themselves as "small business friendly". Their ads give the impression that their vaults are open for entrepreneurs. This is definitely not the case when it comes to small business acquisitions. Yes, they will lend you money, as long as you can fully collateralize it with hard, personal assets (not the business). This is especially true as it relates to restaurants and cafes for several reasons: first, these businesses typically have lots of unreported income and so there are no financials available to substantiate the seller's representation of what the business generates in sales or profits. It's also the reason why restaurants typically sell at lower multiples. It's nearly impossible to find this type of business where it's all on the tax returns. Second, the failure rate in restaurants and cafes is enormous. It's been estimated to be as high as 90% in the first year. Banks don't fund risk, and these are very risky businesses.

What do banks like to finance you ask? Generally, they want businesses that are asset-rich. But, even with those, when it comes to small businesses they want their funding collateralized by the owner and not just the business' assets. This even holds true for SBA loans. Their standards are very rigid in this regard as well. You should also know that seller financing is very much the norm in restaurant purchases and that is the strategy you should follow.

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Goodwill – How to finance it?

Question:
What options are available for financing "goodwill", other than seller notes? How do you finance the business' non-tangible assets?

Answer:
In many cases of small business acquisitions goodwill does represent the greatest asset value. Traditional lenders will almost always want their financing to be secured by a combination of business and personal security. As such, for the business you described, chances are that everything will be dependent upon your credit-worthiness and the available personal security you have to collateralize the loan.

Most prospective business buyers are not in a position where they can secure a note. That's why seller financing is your best and sometimes only viable option.

There are of course other sources for financing such as venture capitalists or angel investors; however, they usually don't get involved in small business purchases. As with family/friends, good luck...it's usually the quickest way to make enemies.

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Business owner is in trouble - A failing business with an SBA loan and personal guarantees

Question:
My question is in regards to SBA-backed loans. Two and a half years after receiving an SBA-backed loan my business is running into serious financial difficulty. We are incorporated as an S-corp. My question is about the "Personal Guarantee". If the business becomes insolvent, how likely is it that the lender will pursue actions to recover the loan amount through this guarantee? I’m afraid this could jeopardize personal savings and credit. I have consulted with a bankruptcy attorney; I just wanted to see what your general advice might be.

Answer:
(Note to readers: While I do not wish to harp on this person’s past mistake, his situation is validation of my belief and precisely what we teach in our materials that seller financing is the way to go, because you would have many more options if your business runs into some problems and the seller, rather than an SBA lender, is holding the note.)

I am sorry to hear about your situation. Before I comment on what actions you can expect from the lender, I want to be certain that you meet with the lender ASAP to discuss your current predicament if you haven’t already done so. They may be willing to offer a holiday from payments for a brief period to give you some breathing room.

As far as what their likely actions will be in the event of default, it usually is not a pleasant environment. First, they will likely take over the business in an effort to liquidate the assets. Any shortfall will probably trigger any personal guarantees that you committed when the loan was granted.

Like any lender their preference would be to see you succeed. However, a cost of doing business for them is defaulted loans, and so they can get aggressive in attempting to recapture their investment and then wipe the loan off their books.

While it is good to consult with a bankruptcy attorney, you should also meet with a lawyer that specializes in SBA transactions as they will be the more resourceful party to outline all of the options that are available to you. They will also be in a better position to possibly negotiate with the bank and stave off a foreclosure.

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Should buyer use home equity to buy a business?

Question:
I have found what I believe to be a wonderful business, but there's one problem: I really do not have the necessary money for the down payment. The asking price is $650,000 and the seller will finance $425,000 to a 'qualified buyer'. I only have about $100,000 available in cash. The seller and I get along very well. I have about $200,000 in equity in my house but my wife is very apprehensive about getting a second mortgage. The business makes about $250,000 a year. What would you do?

Answer:
I don't think your wife is going to like my answer, so let's first examine the alternatives. Assuming that you have checked the business as thoroughly as you can at this stage, and it meets your criteria, then it is certainly worth exploring several scenarios:

Getting the seller to finance more:
Have you discussed this possibility with the seller? Although they are financing a substantial portion, perhaps you can explore this option with them and even consider using your home equity as a partial guarantee on the additional financing that they are currently offering. As an example, you now face a $125,000 shortfall. If the seller would consider financing this portion, they could get a second lien position on your home as security for this amount, which would still leave you with $75,000 in equity and the financing you need.

SBA Loans:
If the historical financials can support the debt, this seems like an ideal candidate for an SBA loan. While there are certain criteria that need to be in place for both the business and you, at face value it would seem to meet these. Furthermore, it is well worth you exploring this option. Based upon the SBA and lender guidelines, you have what is needed for a down payment under their general guidelines, and with seller financing in the deal it will bridge any gaps that may exist. I would recommend that you contact a local Preferred SBA lender and discuss the deal with them.

Mortgage the House:
Even though your wife may not be crazy about this idea, it is a solid fall-back plan should the two scenarios noted above not materialize. While I do understand your wife's concerns, it is critical that she is 100% on board with this decision. Although you are buying the business, she's in this as well. From a financial perspective, the potential return that you can make on your investment by utilizing your equity to acquire the business and generate an excellent income, is far superior to other investment vehicles. Nevertheless, it is something for you and your wife to discuss. Personally, I always like to leave the home out of an acquisition unless it's my only option, but I would always be prepared to do so if the opportunity makes sense.

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Seller financing - What are typical terms for seller notes?

Question:
I put an LOI on a $1M ecommerce business, and offered 30% down, with a 6% 10-year note. The broker came back and said the terms were way too low, that seller notes should be prime plus 2-3%, like SBA. Is this typically what seller financing goes for? I was under the impression it was much lower, like 6-7%. Also, what additional terms should I negotiate? Lastly, what are the real advantages, if any, of getting a seller note versus an SBA loan?

Answer:
The beauty of seller notes is that they can allow you far more flexibility in both rate and term than what you can expect from a traditional lender. That being said, the broker has a valid point but, unlike an SBA loan where the rate is not very flexible and is usually around Prime plus 2%-2.5%, with a seller note, it’s all negotiable. I like them to generally be in the six to eight percent range depending upon the prevailing rate.

In addition, seller notes are usually over a shorter time period. While there are no hard statistics on this, an average of 3-5 years is common. As you know, the interest rate is far less important than the term, specifically as it relates to the impact on the business’ cash flow. As such, it would be in your interest to negotiate a longer term, even at the expense of a one or two percent increase in the rate.

Plus, you will want to include the ability to pay off the loan early and make periodic lump-sum payments towards the principal without penalty. On this point, as you get into the business and things are going well, you may find yourself in a position with extra cash in the business. It is an ideal time to offer the seller to buy out the note at a discount.

SBA vs. Seller Financing

There are a couple key issues to consider:

Security: With a seller note, while you will likely have to sign personally, you will not have to pledge personal security and can use the business assets as security. I usually joke that the SBA only wants your first-born. While they aren’t that rigid, it’s usually not far off; they want as much security as possible in most cases.

Timing: SBA and its lenders have improved the timing in which they get deals done, but it still is not a quick process. With a seller note, there’s no delay whatsoever and the note simply becomes part of the closing documents.

Fees: The fees can be quite substantial with SBA loans although the lenders will build these fees into the package and finance them over the note term. However, when you need the money to complete the acquisition, the fees are a small price to pay to get into a good business.

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By: Richard Parker: President of The Business Buyer Resource Center and author of How To Buy A Good Business At A Great Price©

 

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