Buying an existing business can be a smart move, but financing it often poses a challenge. At Unbroker, we’ve helped numerous entrepreneurs navigate the complex process of securing loans for business acquisitions.
This guide will walk you through the essential steps on how to get a loan to buy an existing business. We’ll cover everything from preparing your application to improving your chances of approval.
How to Prepare Your Loan Application
Check Your Credit Score
Your credit score plays a vital role in loan approval. Lenders use it to assess your financial responsibility. Having a FICO score in the mid-600s will help you qualify for a business loan. If your score falls below this threshold, take action to improve it before applying. Pay off debts, fix any errors on your credit report, and avoid new credit inquiries.
Explore Loan Options
Business acquisition loans come in various forms. SBA loans offer competitive rates and terms, with the 7(a) loan program providing up to $5 million for business purchases. Traditional bank loans might have lower interest rates but often come with stricter requirements. Seller financing can offer flexibility but requires strong negotiation skills.
Gather Your Documents
Lenders need a comprehensive view of your financial situation and the business you plan to buy. Prepare these essential documents:
- Personal and business tax returns (past 3 years)
- Personal financial statement
- Business plan with financial projections
- Current financial statements of the target business
- Letter of intent to purchase the business
Create a Solid Business Plan
Your business plan serves as your roadmap to success. Include these key elements:
- Executive summary
- Company description
- Market analysis
- Organization and management structure
- Financial projections (3-5 years)
Maintain realism in your projections. Overly optimistic numbers can raise red flags with lenders.
Calculate Your Down Payment
Most lenders require a substantial down payment for business acquisition loans. The SBA typically asks for 10-20% down, while traditional banks might require 20-30%. Factor this into your financial planning.
Thorough preparation not only increases your chances of approval but also helps you negotiate better terms. A well-organized, comprehensive application can make a significant difference in securing favorable loans.
Now that you’ve prepared your loan application, let’s examine the key factors lenders consider when evaluating your request.
What Lenders Evaluate in Business Acquisition Loans
Business Performance and Valuation
Lenders prioritize the target business’s financial health and market value. They examine historical financial statements, cash flow projections, and industry comparisons. Total Leverage Ratio (Total Debt / EBITDA) is the most common leverage metric used by corporate bankers and credit analysts to assess a company’s financial health.
Businesses with EBITDA margins above 15% tend to attract more favorable loan terms. A comprehensive valuation report (ideally from a certified business appraiser) will strengthen your application.
Entrepreneurial Track Record
Your experience in running a business or working in the same industry as the target company matters. Lenders want to see that you have the skills to manage and grow the acquired business successfully.
SBA loan approval rates vary significantly between large and small banks. Large banks approve SBA loans at rates as low as 20-30%, while smaller banks approve SBA loans at around 40% or less. If you lack direct experience, consider partnering with someone who does or highlight transferable skills from other roles.
Collateral and Down Payment
Most lenders require some form of collateral to secure the loan. This could include business assets, real estate, or personal property. The Small Business Administration typically requires a down payment of 10-20% for their 7(a) loans used in business acquisitions.
Applicants who can offer a down payment of 25% or more often receive more competitive interest rates and terms. If you’re short on cash, explore creative financing options like seller financing or bringing in equity partners.
Industry Outlook and Market Conditions
Lenders assess the broader economic landscape and industry-specific trends. They want to ensure the business has growth potential and can weather market fluctuations.
According to IBISWorld, industries experiencing annual growth rates of 2% or higher are viewed more favorably by lenders. Research your target industry’s projected growth, technological disruptions, and regulatory changes. Present a clear strategy for how you’ll position the business to capitalize on positive trends and mitigate potential risks.
Understanding these key factors will help you present a stronger case to lenders and increase your chances of securing the financing needed to purchase an existing business. Now, let’s explore strategies to improve your loan approval odds.
How to Boost Your Loan Approval Odds
Craft a Compelling Business Plan
Your business plan must impress lenders. Don’t settle for industry averages. Analyze the specific business you plan to buy. Demonstrate how you’ll improve its performance.
If you’re purchasing a restaurant, don’t just promise increased sales. Detail your strategy. You might introduce online ordering. In 2023, 40 percent of consumers opted to order directly from the restaurant website, versus 13 percent who expressed a preference for third-party apps. Or implement a loyalty program (which can increase profits by 25-95%, as reported by Harvard Business Review).
Lenders review numerous generic plans. Make yours exceptional with specific, data-supported strategies.
Build Relationships with Lenders Early
Cultivating connections with lenders benefits small business owners. Those who establish these relationships often secure better terms.
Attend local business events where lenders participate. Join your chamber of commerce. Follow up with lenders you encounter. Share your business aspirations and request advice, even before you’re prepared to apply for a loan.
A Federal Reserve study found that small businesses with existing banking relationships had an 8% higher loan approval rate. These connections often result in more favorable interest rates and terms.
Partner Up to Strengthen Your Application
If your personal finances or industry experience lack strength, consider adding a partner. This strategy can significantly improve your loan approval chances.
Seek a partner with complementary skills and a robust financial history. If you excel in technology but lack management experience, team up with a seasoned business operator. If your credit score is low, find a partner with excellent credit.
The Small Business Administration reports that about 50% of small businesses operate as partnerships. This structure can make your loan application more attractive to lenders by reducing their perceived risk.
Negotiate Like a Pro
Prepare to negotiate. Lenders expect it, and it can lead to improved terms. Don’t focus solely on the interest rate. Consider the loan term, prepayment penalties, and covenants.
For instance, if a lender offers a 7% interest rate with a 5-year term, you might counter with a request for a 7-year term at the same rate. This adjustment could substantially lower your monthly payments, enhancing your cash flow during the critical early years of ownership.
A Nav survey revealed that 20% of small business owners who negotiated loan terms received better offers. It’s worth the effort to ask for improved conditions.
Final Thoughts
Securing a loan to buy an existing business demands meticulous planning and strategic execution. You must prepare a comprehensive business plan, create strong financial projections, and prove your ability to manage and grow the acquired business. Your credit score, industry experience, and the target business’s performance will influence the lender’s decision.
We recommend you explore multiple funding options, including SBA loans, traditional bank loans, and seller financing. Each option has unique advantages that may suit different situations. Prepare to negotiate terms and consider bringing in partners or co-signers to strengthen your application if necessary.
At Unbroker, we understand the challenges of business acquisitions and offer innovative solutions for entrepreneurs. Our platform provides valuable resources and connections that can benefit buyers. We strive to make the business transfer process more transparent and cost-effective for all parties involved.
