Of the many considerations when purchasing a small business, one of the most important is how to finance it.  Even if you have all of the cash you need to buy a business, as a smart investor you will consider whether you are better off borrowing some of the money or bringing in an equity partner to spread the risk.

Each source of business acquisition financing has its benefits and drawbacks. Before you identify a business that meets your acquisition criteria you should understand how large a business you can afford and where you can secure the funds. You can mix and match the financing strategies below depending on your needs and qualifications, and the deal’s size and complexity:

• Family and friends.   If you don’t have the initial capital to acquire a business, consider asking friends and family for help. Those who are close to you and believe in you may be willing to take a chance on your business. The investment could be a gift, a loan or an equity investment in the business. Each have pluses and minuses, and each should be recorded in writing, in many cases a legal document. While a gift may be the most straight forward way for your friends and family to support you, many experts suggest loans as the optimal way for personal relationships to invest in your business plans because there are clear expectations and repayment terms. If you accept an equity investment you are literally turning a friend or family-member into a business partner. This type of relationship can be fraught with challenges and misunderstandings so be sure to clearly define the terms of the investment.

• Seller financing.   Consider asking the seller of the business if he or she can provide financing for the sale of all or some of it. The benefit to the seller is that they may make more on a loan to you than alternative investments available to them. Also by taking a note rather than cash they may be able to defer some of the taxes on the sale of the business. There are benefits for the buyer too. In some cases, sellers may provide more reasonable interest rate than the banks. Also sellers that retain a note still have an interest in the success of what was once their business. This can provide you with a built-in source for advice and guidance.

• Bank Loan.   To obtain a loan from a bank to purchase a business both the target business and the buyer must be able to qualify. The business should have positive cash flow, solid management experience, industry expertise and a strong credit report. You, as the buyer, must have good credit (at least 640 FICO score), business management experience and in some cases personal collateral to back the loan. Many lenders across the country offer small-business loans guaranteed by the U.S. Small Business Administration (SBA) 7a program. These loans provide lenient and flexible financing for qualifying borrowers. SBA loans have low down payment requirements (as low as 10% on some deals), are structured without balloon payments and have up to 10 year terms which keep loan payments low.

One substantial downside to the SBA loans is that they require personal guarantees, putting you personally on the hook for any defaults by the company. Typical bank loans don’t always have this requirement for businesses generating enough cash flow. SBA 7a loans can have higher interest rates than traditional bank loans. They also require more paperwork and a greater time investment in the documentation and approval process.

• 401k/IRA.   An often overlooked source of acquisition funding is your personal 401k or IRA. The benefit of this approach is that there is no penalty for early withdrawal nor requirements to repay the funds back into your retirement vehicle. The Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA) include provisions that permit individuals to invest their retirement funds in stock in their own companies. Often called ROBS (Rollover for Business Start-Ups) the process is fairly straightforward but there are a few legal hurdles, so consult a professional. Also be prudent with your investment as you’ll be risking your retirement savings in your business.

It is important to have a financing strategy prior to making an offer to purchase a business. Contact Adam Wiskind, M&A Broker with Exit Strategies Group, Inc. to discuss your financing options. He can be reached at (707) 781 8744 or awiskind@exitstrategiesgroup.com.

In 2007 I found myself at a crossroads. After almost twenty years on a steady career path, I felt it was time for a change. The problem was that I didn’t know what I wanted to do next. I considered going into consulting, did the mandatory networking with old contacts, and even gave serious thought about doing a start-up. But I didn’t have that one great “do what you love” or “change the world” idea.

It was at that point that I started seriously considering buying an established business in California. I spent a couple of hours each day scanning various business for sale websites, and made quite a few inquiries. I learned quickly that there are many great businesses out there, and that people sell for all kinds of reasons. There was such a variety of businesses to explore that it was much easier for me to eliminate business categories that I didn’t want to look at (for me it was restaurants) than to focus my search on any one particular type of business.

I ultimately came across an interesting company that had established an ecommerce presence selling identification and security products – ID cards and readers, printers, convention badges, lanyards, etc. Despite having no prior experience in the industry, it was an easy enough business to understand and to envision how I could make it work. I had done my homework and knew how much cash flow I needed from a business and how large a transaction I could pull off, and this one fit within my parameters. I made an offer, and after a short negotiation we reached agreement on price and deal structure. As of January 2008, I was the proud owner of my own business.

My wife and I ran the business for seven years until we were ultimately bought out by another firm in our industry. After all of the transaction related taxes and other costs, our initial investment in the business had grown by more than 6x during our seven-year ownership. That works out to an annual rate of return of over 30%. In addition, we were able to pay ourselves a decent salary throughout the time we owned the business. There are not many other investments that can pay your salary and grow your net worth at the same time.

In case you missed it, we bought the business in January 2008 – just a few months before the biggest financial crisis in a generation hit. Our timing could not have been worse. Because of the financial crisis, we didn’t come anywhere close to hitting the sales and profit targets that I had projected. In fact, it wasn’t until 2011 that we achieved total sales greater than 2007 – the year before we became the owners. But despite the bad timing, purchasing a business was the best financial decision I ever made.

Mark Soeth is an M&A Advisor with Exit Strategies Group’s Sacramento California office. 

So you want to be your own boss ― no superiors, no shareholders, and no board of directors. Consider the options ― you can work as an independent contractor, start your own company, or buy an existing business. Each option has benefits. If you analyze the risks-versus-rewards carefully, you’ll learn what many seasoned entrepreneurs have discovered … the scale tips in favor of purchasing an existing business.

Admittedly, as an independent contractor (including sole practitioner professional practices and consultants) your risk is minimal and the initial investment and overhead costs are relatively low. You can make a comfortable living; however, without the ability to leverage the work of others, your personal production will probably limit financial returns and equity growth.

Starting a business may pay great dividends over time, but it’s important to understand that most start-up businesses falter and eventually fail. According to Michael Gerber, renowned author of The E-Myth Revisited, 40 percent of new businesses fail in the first year and 80 percent fail within 5 years. Poor planning (choice of location, market, product or service) and being undercapitalized are common causes of failure.

On the other hand, purchasing an existing business, when done correctly, reduces an entrepreneur’s risk and provides the opportunity for a return on equity. There are a number of reasons to consider purchasing an existing business rather that starting one:

• Cash Flow on Day One. Acquisitions are often structured so that you can take a reasonable salary, cover the debt service on acquisition financing, and have some money left over. Owners of start-up businesses, on the other hand, often starve for months or years.
• Proven Business Model. Buying an established business is less risky ― as a buyer you already know the process or concept works, and the products, services, location and markets are proven. Lots of expensive mistakes have already been made in order to get it right.
• Acquisition Financing. Existing businesses have a track record of viability. Securing financing for a business acquisition is far easier than funding a start-up for that very reason. A bank can rely on actual historical results for that specific business, not just plans and wishful projections.
• Recognized Brand. Chances are the seller spent years building a brand. That brand recognition and any marketing the seller has done should transfer to you. When you have an established name and presence in the business community, it’s easier to make cold calls and attract new business than with an unknown, unproven start up.
• People & Relationships. In a small business acquisition, one of the most valuable and important assets you’re buying is established relationships with people and allied businesses. It took the seller time to find employees, develop them and assimilate them into the company culture. With the right team in place, you will have an easier time implementing growth strategies, and more opportunities to spend time with family, take vacation, or work on other business ventures. In start-up mode, when you go on vacation, the business goes with you. When you purchase an existing business, you also usually buy an existing customer base, vendor base, and other strategic relationships that took years to develop. It’s common for the seller to stay on with the business for some time to ensure that these relationships are properly transferred.
• Focus on Growth. You may be wondering if buying an existing business leaves enough room for innovation and creativity. Experienced entrepreneurs know that starting a new business means spending a lot of time and money on basic necessities like computers, telephones, furniture and equipment, policies, insurances, permits, recruiting, and numerous other infrastructure and tasks that don’t directly generate cash flow. When you purchase an existing well-run business, because the seller has already laid the foundation, made and corrected the mistakes, incurred the usual string of start-up losses and dispensed with the time-consuming and tedious start-up work, you should be in a position to focus on business improvements, innovation and growth soon after you take the reigns.

Becoming your own boss involves risk, but by successfully purchasing an established business, you can reduce the risk of failure associated with a start up and enjoy the opportunity to build enterprise value over time.

Al Statz can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.