Posted 05-17-2019 4:25 pm by
The phrase “no money down” is typically associated with buying real estate. There are numerous courses, books, and influencers teaching people how to buy properties using other people’s money. This leads to a curious question for business buyers… Is it possible to buy a business without using your own money?
To answer this question, let’s examine the common financing sources when it comes to buying a small business:
1. SBA financing. Getting an SBA loan is one of the best ways to buy a small business. In the lending environment of 2019, banks are willing to lend up to 90% of the purchase price. Right off the bat, it means you can purchase a business with as little as 10% down. If you have good credit, interest rates typically range between prime + 2% to prime + 2.75%. In other words, if the current prime rate is 5.5%, the interest rate on the SBA loan will likely range between 7.5% and 8.25%. The term of the loan is typically seven to ten years. Some lenders may be willing to fix the interest rate for one year, three years, or five years. Typically the longer you fix the interest rate, the higher interest rate you pay. In most cases, the bank will require the buyer to get a lease term that is equal or longer than the term of the loan. In other words, if you are getting a 10-year SBA loan, it means you need a 10-year lease from the landlord. The good news is that renewal options also count. If you have a 5-year lease + a 5-year option to renew, it will also satisfy the bank’s requirement. If you have a 4-year lease + two 3-year options to renew, it will also satisfy the bank’s requirement. The bank will require the buyer to use the buyer’s personal residence or rental properties as collateral in addition to using the business assets as collateral. If the buyer does not own a house, then the bank will not require the buyer to use a personal residence as collateral. Typically, an SBA loan can be obtained in 45 to 60 days.
2. Seller financing. Another popular source of financing is to ask the seller to carry a portion of the purchase price, although the reality is not as presented by many influencers. There are a number of influencers teaching people how to buy a business that teach their students to get the seller to finance 70% to 90% of the purchase price. The reality is that most sellers do not want to be a bank. Most sellers want to be cashed out at closing. If your objective is to only buy from sellers who are willing to finance 70% to 90% of the purchase price, it would take a massive amount of time, going through many, many failed deals and wasted time in negotiations before finally finding a seller who is willing to do so. Another aspect to consider is the quality of the business when the seller is willing to finance 70% to 90% of the purchase price. If you come across a really good business and several other buyers are willing to give the seller all cash at closing, and you are the only buyer who asks the seller to finance 70% to 90% of the purchase price (effectively only giving the seller 30% to 10% cash at closing), why would the seller sell to you? In our experience, good businesses typically go very fast. It is not unusual to have more than 50 interested parties when we have a good business for sale. If a buyer is asking the seller to finance a major portion of the purchase price, that buyer is typically passed up right away as a non-serious buyer. In today’s market, it may be reasonable to ask the seller to finance 5% to 10% of the purchase price, or none at all. Some desperate sellers or sellers of less attractive businesses may be willing to finance 50% of the purchase price. Just keep in mind that business sellers are not banks, and they do not want to be a bank. Be very careful how much you ask the seller to finance in your offer, or you may lose out on a good opportunity.
3. Less-productive assets. Selling less productive assets and using the money to buy a business is a great way to come up with the down payment needed. Perhaps you inherited a piece of raw land that is not producing any income. Perhaps you have some rental properties that are barely cash flowing, and you can sell them and buy a business with much higher cash flow. Perhaps you have some antiques, junk in the storage unit, jewelry, spare furniture, vacation house, timeshare, old cars, or other items you don’t need that can be sold and converted into an income-producing asset by buying a cash-flowing business. For comparison purposes, money in the bank produces less than a 1% return annually. Rental properties typically get 4% to 6% cash-on-cash return if managed properly. Dividends on stocks are in the 2% range. Junk bonds are paying 5% of higher a year, but you are risking your capital by lending to questionable sources. By contrast, buying a solid, well managed, solid business can often produce cash-on-cash returns of 50%, 80%, 150%, or more. If you want to maximize your cash flow, one of the best ways to do so is buying an existing business that has been proven to be profitable for years.
4. Retirement plan. Many business buyers who feel like they don’t have the money to buy a business are surprised to find out that they can use the money in their 401(k) or retirement account to buy a business without incurring any early withdrawal penalties. If you have at least $50,000 in your IRA or 401(k), there are companies such as Guidant Financial that can set up a ROBS for you so you can use the money in your retirement plan to buy a business.
5. Friends and family. If the SBA loan can lend you 90% of the purchase price, it is possible to ask for a loan from friends and family for the 10% down payment. The key is to be prepared. Have a business plan. Be professional. Show them the numbers. Ask gently, and don’t give your friend, family member, or investor a hard time if they decide to pass on the opportunity.
6. Specialty lenders. For those business buyers with less than ideal credit, there are specialty lenders that cater to people without access to traditional sources of financing. Rather than being loan sharks, these specialty lenders often carry a social mission to help the local economy, community, and the environment by supporting entrepreneurs who cannot get loans from commercial banks. One example of a specialty lender is Craft3, which has been serving the Pacific Northwest since 1994.
7. Crowdfunding. There are crowdfunding sites for art projects, charity, and business investments. The key to getting crowdfunding to buy a business is using the right crowdfunding site. Some of the crowdfunding sites for business investments include Fundly, CrowdFunder, Indiegogo in partnership with MicroVentures, SeedInvest, and WeFunder.
8. Sweat equity. One of the most creative ways to buy a small business is to work for the business you want to buy someday, rise up to the management position, and make yourself indispensable to the owner. After years of sweat equity and proving your worth to the owner, you may very well convince the owner to make you a partner or let you buy the business from the owner. It is not uncommon for a business owner to sell the business to one of their employees. It allows the business owner to pass on his or her legacy to a trusted individual rather than selling the company to a stranger or a competitor. When the business is sold to an employee, the owner is often times very willing to finance a large portion of the purchase price, and even sell the business at a discount, in order to help the trusted employee (who often lacks the financial resources) to buy the business. Using sweat equity to buy a business takes time and effort. Most people want shortcuts to wealth. Unfortunately, there are no shortcuts; only calculated risks. If you have exhausted your other options, working your way up to buying the business may be the way to go.
Aaron Muller is a leading business broker in Washington State who has sold over 200 companies and facilitated over 50 SBA loans for his clients. Contact Aaron at (425) 766-3940 to inquire about selling your business. For a free video tutorial on how to buy a business using other people’s money, visit www.LBOClass.com.