Some entrepreneurs don't start their journey as business owners from scratch. In fact, many entrepreneurs begin their business ownership by acquiring existing businesses. However, how do they obtain the necessary funds for such a purchase? Apart from using cash, there are several methods accessible to finance the acquisition of a business.
Financing the acquisition of a business can be achieved through different sources of funding, including traditional banks, online lenders, and the Small Business Administration. Securing financing for a successful existing business may be simpler than for a new venture that is still in the early stages of establishment.
Let's explore the various methods by which business buyers can finance an acquisition.
Self-Funding
Termed as bootstrapping, self-funding enables you to leverage your own financial assets to support your business. This method could include obtaining funds from family and friends, utilizing personal savings, or tapping into your 401(k) funds.
Self-funding grants you complete control over your business, but it also entails taking on all the associated risks. It’s important to budget wisely and be cautious, particularly when contemplating early withdrawals from retirement accounts. Such decisions could lead to significant fees, penalties, or have a detrimental effect on your retirement goals. It is recommended to seek advice from your plan's administrator and a financial advisor before taking any steps.
SBA
SBA loans, short for Small Business Administration loans, are partially guaranteed by the U.S. Small Business Administration (SBA) and issued by approved lenders, usually banks.
Loans backed by the SBA cater to businesses of all sizes and can support a variety of needs, including long-term assets and operational costs. Different loan programs may have restrictions on usage, which will be explained by an SBA-approved lender.
Some of the benefits of SBA lending include competitive terms, support, education, and unique perks like lower down payments and no collateral required for certain loans, while some of the downsides of SBA lending include multiple qualifying requirements and a potentially lengthy process to secure the funds.
Earnouts
A creative way to fund a business acquisition is an earnout strategy. An earnout is a contractual arrangement where the seller is entitled to extra payment if the business meets certain financial targets in the future. Typically, these targets are based on metrics such as gross sales or earnings.
Connecting payment to future financial performance through an earnout can reduce uncertainty for the buyer. Initially, the buyer pays a portion of the business cost, with the remainder dependent on achieving future performance goals. This setup enables the seller to partake in future growth for a specific duration. Different financial goals, like net income or revenue, can impact the design of earnouts.
Seller Financing
Seller financing enables business buyers and sellers to sidestep traditional banks and work together to secure a funding arrangement. Normally, buyers must finance the entire purchase on their own. However, with seller financing, the seller acts as the bank, taking on the loan financing, and the buyer reimburses the seller in increments along with interest.
A seller's readiness to offer financing typically reflects confidence in the health of the business and the business's capacity to generate ample income for loan repayment. For some buyers, a seller's hesitation to provide financing might raise concerns about the business's stability.
Determining the funding for acquiring your business marks a vital first move towards ownership. For further information on funding options and the entire process of buying a business, reach out to Transworld Boston to consult with a knowledgeable and reliable advisor.
