Qualify for a Loan to Buy a Business
It’s unusual if not bad form to buy a business and pay all cash for the purchase. If you pay cash and have no debt, surely that’s good business? Here’s why that’s not the case.
- If you buy a business with a loan, the interest is tax deductible.
- If you buy a business and pay cash of $300,000 that generates an annual profit of $100,000 that sounds great. However, if you buy a business for a price of $600,000, make a downpayment of $200,000 and borrow $400,000 and it makes $200,000 per year doesn’t that sound better? I understand you need to re-pay a loan of $400,000 but if this is an SBA loan repaid over 10 years at an interest rate of 6.5%, the monthly payment would be $4,542. Over 12 months this totals $54,504. In this scenario as the buyer of the business, you get to keep $100,000 of your $300,000 to invest somewhere else, the annual profit is $200,000 less an SBA loan payment of $54,504 meaning as the owner you get to keep $145,496 and the interest on the loan is tax deductible.
If you are comfortable servicing a loan to buy a business and if you have the cash downpayment available, how do you qualify for a loan to buy a business?
How do I qualify for a loan?
To qualify for a loan there are four steps to take and if you are successful completing these four steps you will pre-qualify for a loan. Being pre-qualified for a loan does not mean your loan is approved. It does mean however, to keep looking to find the right business and make an offer. If you and the seller are both able to come to an agreement on the price and terms, you’ll have a much greater probability of being able to close the deal and become a business owner.
The four steps to take are as follows:
- Complete a Personal Financial Statement. Click this link if you would like to download a sample SBA Personal Financial Statement.
- Review your credit. Different lenders have a different process. Some lenders will allow you to download and provide your own credit report. These lenders understand that having a lot of activity against your credit report is not good and so will work with you. Other lenders wish to get your authorization so they can run the report themselves.
- Provide a current bank statement showing you have the downpayment available.
- Provide a current copy of your resume. This step is critical if you plan to get an SBA loan because the lender wants to see you have experience in the industry of the business you are buying. Additionally, if you have management experience, make sure to detail this clearly including the job description, how many direct employees were reporting to you and over what period of time. The number one reason SBA borrowers are not successful is because they don’t have business management experience.
What happens if your downpayment or part of it is in the form of a gift or will come from an ‘investor’? The lender will wish to see the downpayment in a bank account in your name so they know the money is available. Some lenders may have a conversation with the person making the gift or investor. Often this is to know if it’s actually a gift or a short-term loan that needs to be repaid. If it’s a short-term loan then the bank will treat this as part of the total debt servicing of the deal.
Did I mention the best part about a Prequalification Letter? Most, if not all lenders, will provide this letter to you at no cost.
What are the advantages of pre-qualifying for a loan?
If you pre-qualify for a loan it gives you a number of advantages. These include:
- Showing a seller you are serious about buying a business.
- Showing a seller your finances and credit have been reviewed by a third party and if the business presents well, the lender would be willing to approve finance to close the transaction.
- Allow the transaction to close much quicker than a buyer who is yet to start this process.
- Provide you with a competitive advantage if there is more than one buyer looking at buying the business. If the other buyer doesn’t have a Prequalification Letter, the seller will invariably go with the buyer that does have one.
What are the reasons SBA loans are declined?
- Poor Cash flow. A business relies on cash flow to feed the owner, pay wages, pay rent and more. A business with a strong cash flow will mitigate many other weaknesses in the loan application process.
- As mentioned above, lack of direct industry experience and management experience.
- Not enough down payment. As the banks say, they want to see skin in the game.
- Poor trends in the industry. If an industry is going through lots of change then the cash flow may be compromised.
- The amount the buyer wants to borrow is too large for the amount of collateral or assets to secure the loan. Almost without exception an SBA lender requires a personal guarantee on the assets of the borrower. Also, loans with over $500,000 of intangibles now need at least 25% downpayment between the buyer and the sellers note.
What happens if I’ve had a personal bankruptcy?
If you are applying for an SBA loan you are required to let them know if you have ever filed a personal bankruptcy. You are also required to declare if you have not paid a Federal Student Loan or had an IRS Tax Lien settlement.
Read More: Search our database of businesses for sale.
Don’t forget your Life Insurance
If you plan to get an SBA loan, one of the requirements to close the transaction is to make sure the lender appears as a beneficiary on the life insurance policy. This often takes time to process so don’t leave it to the last minute.
For more immediate help with buying a business you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.