Different Ways to Finance a Business Acquisition
Not all entrepreneurs start their business owner journey from scratch. That’s right – many entrepreneurs become business owners through buying existing businesses. So, how do they find the funds necessary to make such an acquisition? Aside from good old cash, there are several different ways to finance a business purchase.
Financing a business purchase can be done through various lenders, such as traditional banks, online lenders, and the Small Business Administration. If the existing business is already successful, obtaining financing might be easier compared to funding a new business that is yet to establish itself.
Let’s dive into the different ways business buyers can fund an acquisition.
Self-Funding
Known as bootstrapping, self-funding allows you to utilize your own financial resources to back your business. This approach may involve seeking capital from family and friends, using personal savings, or accessing your 401(k) funds.
Self-funding grants you full control over your business, but it also means bearing all the associated risks. It's crucial to spend within your means and exercise caution, especially when considering early withdrawals from retirement accounts. Such actions could result in substantial fees, penalties, or impact your retirement plans negatively. It's advisable to consult with your plan's administrator and a financial advisor before proceeding.
Earnouts
When buyers and sellers cannot agree on the price, they can use a strategy known as an earnout. An earnout is a contractual provision that stipulates the seller will receive additional compensation if the business achieves specific financial goals in the future. These goals usually revolve around metrics like gross sales or earnings.
By linking payment to future financial performance, an earnout decreases uncertainty for the buyer. The buyer initially pays a portion of the business cost, with the rest contingent on meeting future performance objectives. This arrangement allows the seller to benefit from future growth for a certain period. Various financial targets, such as net income or revenue, can influence the structure of earnouts.
SBA
Business loans known as SBA loans are backed in part by the U.S. Small Business Administration (SBA) and provided by approved lenders, typically banks.
These loans, guaranteed by the SBA, cover a wide range from small to large businesses and can fund various business needs, such as long-term assets and operational expenses. Certain loan programs have specific usage limitations, which will be detailed by an SBA-approved lender.
Some of the benefits of SBA lending include competitive terms, support and education and unique perks such as lower down payments and no-collateral needed for some loans. Some of the downsides of SBA lending is there are several requirements to qualify and it can be a lengthy process to actually receive the funds.
Seller Financing
Seller financing allows business buyers and sellers to bypass bankers and collaborate directly to reach a funding agreement. Typically, buyers are required to finance the full purchase amount, but with seller financing, the seller agrees to finance the loan, and the buyer repays the seller in installments with interest.
The seller's willingness to provide financing often indicates confidence in the business's ability to generate sufficient income to repay the loan. Some entrepreneurs view a seller's reluctance to offer financing as a potential red flag for the business's stability.
Determining how you’ll fund your business acquisition is one of the first and necessary steps towards ownership. To learn more about these types of funding and all of the steps in the business buying process, contact us at Transworld Oregon Central to speak to an experienced and trusted advisor.
