3 Ways to Finance Your Business Acquisition
For many would-be entrepreneurs, the idea of buying a business is very appealing.
The freedom to be your own boss, collaborate on projects with like-minded individuals, and the possibility of building wealth through equity ownership are some of the reasons many choose this path.
There is also the ability to mitigate risk. Of all businesses started in 2014, only 56 percent made it to the fifth year (2018).
Purchasing a business can significantly increase your chances of success.
There are hurdles, of course.
Depending on your target industry and business model, a business acquisition can be costly. Prices can range from a few hundred thousand to tens of millions of dollars.
It is worthwhile to consider your financing options prior to beginning your search. Here are three ways to finance the purchase of your business.
The Small Business Administration, or SBA, is a government agency whose mission is “to maintain and strengthen the nation’s economy by enabling the establishment and viability of small businesses.”
There is a public misconception that the SBA makes loans to small businesses.
That’s not true.
The agency provides free business counseling, home, and disaster business loans, federal government contracting, and SBA guaranteed business loans.
By providing loan guarantees, the SBA helps businesses obtain financing. Lenders, including traditional banks, community development financial institutions, and microlenders reduce their risks by offering SBA guaranteed 7(a) loan.
Here’s how it works.
The SBA creates guidelines for these loans which makes it a little easier for businesses to qualify for financing.
The SBA guarantees up to 85 percent of loans below $150,000 and up to 75% of loans over $150,000.
The maximum amount of an SBA loan is $5 million. In the event of a default, the SBA covers the guaranteed amount which reduces the lenders’ risk.
SBA loans require the borrower to put up collateral. And any owner of 20% or more must sign a personal guarantee.
Personal guarantee’s hold borrowers responsible for the outstanding loan amount and will put your personal assets at risk.
Consult with your financial professional to determine if an SBA loan makes sense for you.
You may have heard the phrase, “everything is negotiable.”
In many cases, that may or may not be true. When you’re buying a business, expect to negotiate until you come to a win-win agreement with the seller.
The most important negotiable term is seller financing.
With seller financing, the seller agrees to hold a promissory note in the amount of a percentage of the purchase price.
The terms and interest rate are negotiable.
I recently looked at a deal where the note was for 5 years, with a 10-year amortization schedule, at 8% interest, fixed.
Some of the advantages of obtaining seller financing include:
· Lower cost of capital
· Quick close
Of course, there are cons as well. They include:
· Seller may require a personal guarantee
· Collateralizing business assets
· Seller may require a prepayment penalty
By negotiating the terms and conditions of the deal to reach a favorable agreement for both parties is crucial.
Make sure to consult with your business attorney on how to structure and negotiate your deal.
Rollover for Business Startups (ROBS)
Bootstrapping your own business acquisition is a great way to take control of the process.
Leveraging your existing assets can help you seal the deal.
A relatively unknown form of financing is the Rollover for Business Startups, or ROBS.
A ROBS allows you to use your 401(k) funds to finance a business without borrowing or withdrawing funds. You can start a new business or purchase an existing one through a ROBS.
Here’s how it works.
You’ll open a ROBS 401(k) which requires that you establish a c-corporation. You’ll also open a new 401(k) within that corporation.
After which, you’ll roll over the funds from your existing 401(k) into the new ROBS 401(k).
This is not a loan so you’ll avoid filling out any loan documents. This is also not an early withdrawal so you’ll avoid the 10% early withdrawal penalty, assuming you’re 59 ½.
The IRS allows this transaction so this is not considered a taxable event.
Once you’ve funded the ROBS 401(k), you have the option to use the funds to finance your new business or acquisition.
Be sure to consult with your business attorney and financial planner.
Acquiring an existing business is a calculated way to reduce your risks and increase the probability of building a sustainable enterprise.
Working with the right advisors will help you navigate some of the challenges and put you in a great position to focus on what you do best; fulfilling your personal and professional goals.