In this article we cover:
Three of the five types of loans we will discuss are U.S. Small Business Administration 7(a) loans, while the other two are term loans and commercial real estate loans. Letâs take a look at each of these loan options:
SBA 7(a) Loan
The 7(a) loan is the SBAâs most popular loan because the proceeds can be used for a range of business uses. One of those uses is assisting in the acquisition of an existing business. In addition to the standard 7(a) loan, the SBA created two variants of it to help businesses that have slightly different needs.
For your business to be eligible for a 7(a) loan, it must operate for profit (this means nonprofits are ineligible), be considered a small business as defined by SBA, be engaged in (or propose to do business in) the United States or its possessions, have reasonable invested equity, use alternative financial resources (including personal assets) before seeking financial assistance, be able to demonstrate a need for a loan, use the funds for a sound business purpose, and not be delinquent on any existing debt obligations to the U.S. government.
The differences that we discuss in this article among the three 7(a) loans are the loan amount and the turnaround time. This will give you a high-level understanding of which of these three 7(a) loans you should pursue. Depending on the lender, each of these will also have different qualifications, interest rates, payback terms, etc. Although we touch on qualifications in the article, a good resource to learn more about the qualifications and requirements of SBA loans is our guide to Understanding SBA Loans to Small Businesses.
- Standard 7(a): Maximum loan amount is $5 million, SBA turnaround time 5-10 business days
- 7(a) Small Loan: Maximum loan amount is $500,000, SBA turnaround time 5-10 business days
- SBA Express: Maximum loan amount is $350,000, SBA turnaround time within 36 hours
There are times when a business might know ahead of time when it wants to purchase a business, and there are other times when it might come out of the blue and quick action is needed. The SBA has done a great job providing three types of business loans based on turnaround time and the amount of money you need.
Interest rates on 7(a) loans are negotiated between lenders and borrowers but canât exceed the SBA maximums. Head over to SBAâs official web page on 7(a) loan interest rates.
The fourth type of loan that can be used to purchase a business is a term loan. Term loans are offered from traditional financial institutions like banks and credit unions, and also online lenders. Term loans help with the purchase of a business because you receive the loan proceeds as a lump sum. You can receive a larger term loan to purchase the business outright, or a small term loan and use the proceeds as a down payment based on the financing youâve worked out with the business you are trying to purchase. Loan amounts, interest rates, turnaround times, and requirements will vary depending on which route you choose so the small business owner will have to do additional research.
To give you a general sense and a point of comparison when you are doing your term loan lender research, consider what Biz2Credit offers and its requirements:
- Loan amounts from $25K – $500K
- Rates start at 7.99% but individual rates vary depending on credit score, credit history, and other factors. Discounts are possible for businesses that authorize a direct online connection to their company’s bank account.
- Get funded as soon as 72 hours
- Annual Revenue Greater than $250k
- 660 Credit Score or Above
- At least 18 months in business
You will need to review several term loan lender options to determine which is right for your specific business situation.
Commercial Real Estate Loan
The fifth type of loan that can be used to purchase a business is a commercial real estate loan. Businesses can leverage their existing commercial real estate equity to secure a loan. Similar to the term loan above, the loan specifics and requirements will vary depending on the lender. To give you a general sense and a point of comparison when you are doing your lender research, consider what Biz2Credit offers and its requirements:
- Loan amounts from $250K â $6M
- Rates start at 10%
- Qualify as soon as 48 hours
- Annual Revenue Greater than $250k
- 660 Credit Score or Above
- At least 18 months in business
- Already own commercial property
You will need to review several commercial real estate lending options to determine which is right for your specific business situation.
Consideration when purchasing a business
Beyond what loan to use to purchase a business, there are other elements to the acquisition process that should be considered.
- Business Valuation: The goal is to purchase a business at fair market value. Knowing how the business was valued is important and you can ask that question during negotiations. Certain businesses have valuation best practices like a multiple of revenue. To better understand the valuation process, review our article titled How to Put a Value on your Business.
- Credit History: Your credit report impacts the interest rate you are offered and your repayment terms. Minimum credit score requirements vary depending on the type of lender, the type of loan, and the size of the loan. Existing businesses will have their business credit score pulled from business credit bureaus Dun & Bradstreet, Experian, and Equifax. A new business without a lot of history will likely need a personal credit score of the owner pulled. In some cases, the lender might ask for both. Financial institutions like a traditional bank or credit union might weigh a personal credit history more than an online lender. Having good credit will help with qualifying for a loan with lower interest rates.
- Added operational expenses post-purchase: After the deal has closed and you have successfully purchased a business, you will likely have added to your business expenses because you now have to operate the new business or absorb it into your existing one. To help pay for those added operational expenses (and any upfront fees incurred in the purchase process) a business has two excellent options: a business credit card and a business line of credit. Depending on your credit limit, a business can use both in tandem to manage cash flow and monthly payments associated with the new expenses.
- Franchise: If the business you are looking to purchase is a franchise, some franchises offer financing and special assistance. Franchises can offer reduced fees or eliminated fees, direct financing, or offer a special financing arrangement with a pre-determined lender to franchisees to get loans. The SBA also has a special loan for those looking to purchase a franchise. Review the SBA Franchise Directory to determine if the franchise you are considering opening will work with an SBA loan. The SBA also has a guide called Buy an existing business or franchise. The guide is broken out into three sections: Know the difference between franchising and buying a business, Consider three factors before franchising or buying a business, and Get ready to buy your franchise or business.
- Equipment loans: An equipment loan or equipment financing is a type of small business loan used primarily to purchase business equipment like machinery, vehicles, commercial kitchen equipment, or any other type of business equipment. In certain cases, a business might want to purchase another business to obtain its equipment. For example, a manufacturing or farming operation. An equipment loan can be used in this situation. For more information, visit our guide on equipment financing.
- Working capital loans: The proceeds from working capital loans are not intended to be used to purchase a business. Working capital loans are intended to be used to operate an existing business and loan payments are made from your business receipts. Unfortunately, this type of loan is not an option to purchase a business.
- Invoice financing: Similar to a working capital loan, an invoice financing loan is a form of asset-based financing. A business owner receives an advance of capital in exchange for unpaid invoices or accounts receivable. The proceeds of invoice financing loans are intended to be used for working capital.
- Collateral to secure the loan: A lender might require that you collateralize the loan or provide a personal guarantee for you to qualify. You can provide assets such as personal property as collateral for your loan. According to the SBA, these are the collateral requirements for the 7(a) loan program:
- Standard 7(a): Lenders are not required to take collateral for loans up to $25,000. For loans over $350,000, the SBA requires that the lender collateralize the loan to the maximum extent possible up to the loan amount. If business fixed assets do not âfully secureâ the loan the lender may include trading assets (using 10% of current book value for the calculation) and must take available equity in the personal real estate (residential and investment) of the principals as collateral.
- 7(a) Small Loan: Lenders are not required to take collateral for loans up to $25,000. For loans over $25,000, up to and including $350,000, the lender must follow the collateral policies and procedures that it has established and implemented for its similarly-sized non-SBA-guaranteed commercial loans, but at a minimum, the lender must take a first lien on assets financed with loan proceeds and lender must take a lien on all of the applicantâs fixed assets including real estate. The lender is not required to take a lien against the applicantâs real estate when the equity is less than 25% of the fair market value. The lender may limit the lien taken against real estate to the loan amount.
- SBA Express: Lenders follow collateral policies and procedures that the lender has established for its non-SBA-guaranteed loans
Business loan consultants
For businesses thinking about purchasing another business using a loan, business loan consultants can help. Business loan consultants are a fee-based service that helps small business owners navigate the entire business loan process and understand their business financing options. Business loan consultants can:
- identify the right loan product or type of financing based on your business
- streamline the entire loan application process by gathering the right documents, preparing applications, submitting paperwork, and working directly with the lender on any follow-up questions
- help prepare a business plan
For entrepreneurs whose most precious resource is time, or first-time borrowers who are overwhelmed with the application process, a business loan consultant can be worth the investment. For more information, read our article How to Find Business Loan Consultants Near Me.