Many people strive for success in their own business. There are numerous ways to be the owner of a thriving business, whether it be from building the business from the ground-up, or purchasing an already established operation. Despite the same end-result, the different methodologies employed in creating versus buying a small business are very important. One especially important factor in buying versus starting a small business is the way in which you obtain your funds. After all, without proper financing it is almost impossible to be successful with your small business! This article outlines some of the key factors and processes of obtaining funding for your small business purchase.

Valuation and Calculation

Before you can go about sourcing funds to buy a small business, it is important to know a few things about the business. Aspects of the business such as a valuation are essential, as it will tell you how much the business is actually worth. This valuation is a culmination of a few factors, including the businesses debt, profits/revenues, and potential revenues in the future. Furthermore, it is important to look at the potential Return on Investment (ROA) that the potential business has. Other important metrics to keep an eye on when valuating a potential business are their tangible assets, cash flow method, and in-tangible assets.

Another area of importance is realizing a “breakeven point” for the purchase of a small business. The breakeven point is the amount of ROA on your investment that is necessary to “breakeven”, or recoup the initial investment. Essentially, the importance of the breakeven point stems from it being an indicator of success or failure; if your investment falls below this point then you are losing money on the investment, and subsequently failing. There are other metrics of success, failure, and general valuation. However, the ones touched upon so far are some of the biggest indicators of if and how much you should spend when purchasing a small business.

Funding Methods

The funding your small business purchase can come from a variety of places. Therefore, which source of funding you determine best fits you is a personal preference involving a few key factors, such as personal finances, credit, and tolerable risk-level. For example, bank loans may be more risky for some people than others. On the other hand, some people deem utilizing personal finances and savings as something that they cannot afford to do at the time. There are many factors at play and options available when attempting to finance buying a small business, and here are just a few:

Personal Funds

Personal funds can be an excellent source of funding for your small business purchase. For example, this method allows you to purchase a small business without the incurrence of large sums, or sometimes any sums, of debt. However, it can be very scary to use all of your personal savings for a purchase. These savings could have been set aside for family, emergencies, or a home purchase. Therefore, it is essential that you take the necessary preparation steps before deciding to leap into buying a small business; this is especially true when spending money that you have worked long and hard for, as opposed to a loan. However, be mindful in the fact that bank loans have many pros and cons of their own!

Bank Loan

Bank loans are an option that many people pursue when financing the purchase of a small business. Despite being a popular and viable option, it is recommended that people are very careful before and while taking out a bank loan for a few reasons. Primarily, an ill-advised or ill-planned loan can result in lost funds, and in turn debt for the loanee. This debt can affect not only your business, but personal life, and cause major setbacks. For that reason, organizations such as the Small Business Administration (SBA) recommends working with an professional, such as an accountant and an attorney, to help you navigate this process. This navigation includes a viable and accurate business valuation and negotiating reasonable interest rates before accepting any and all loans.

Another important aspect to consider before taking out a loan for the purchase of your small business is the tax and personal finance requirements. Banks do not just lend out money to anyone that walks in their doors. Therefore, coming prepared to the bank by having your personal and any prior business finances in order will assist you in getting a loan at a quality rate. Furthermore, it is important to be acquainted with the finances of the organization that you are looking to purchase. Banks are hesitant to loan money to buy a business that they think lack of profitability or have prior debt.

Crowdfunding

Crowdfunding allows people to invest in your business expenditure without gaining a share of it. Unlike normal investors, who often ask for power or returns from the business, crowdfunding relays solely on people giving sums of money because they believe in your expenditure. For that reason, crowdfunding is one of the less risky sources of obtaining funds to buy a small business in many ways. Crowdfunding has the benefit of obtaining funds with no debt or risk to personal funds. Furthermore, this method leaves you with complete ownership of your new small business. Nevertheless, crowdfunding has consequences of it’s own. For example, not all crowdfunding projects end up meeting the necessary financial goals. In these cases, relying solely on crowdfunding can leave people without the funds to actually buy a small business. Crowdfunding is a great source of obtaining funds, but should rarely be the only or primary source.

Seller Financing

Seller financing is an option that allows for a deal between yourself and whomever you are purchasing the business from. In this arrangement, the buyer puts down a smaller lump sum to buy the business initially. Subsequentially, the buyer agrees to pay the remainder of an agreed-upon valuation for the business through payments. These payments often stem from the profits of the new/renewed business, and are more gradual. There are many benefits for both the buyer and seller that utilize seller financing. For example, the seller could agree to get a slightly higher amount for their business than they would have for a total lump sump payment. On the other hand, the buyer is given time to make payments and able to leverage business funds to help the purchase “pay for it self”.

If you are interested in buying a small business and do not want to take out a loan, seller financing is an excellent option to discuss with the current business owner!

Small Business Administration Loan

Small Business Administration (SBA) loans are another great source of obtain funding to purchase a small business. One of the more popular forms of loans from the SBA is the 7(a) loan. The SBA 7(a) loan can be utilized for many small business purposes. These include needing short- and long-term capital, refinancing current business debt, and obtaining new businesses or real estate. The SBA 7(a) loan is the most commonly utilized loan by small businesses. There are many benefits to this loan, as opposed to a traditional bank loan. Amongst these benefits are lower down payments, lower interest rates, and more lenient barriers for obtaining the loan.

Lender’s Considerations

Lenders consider a variety of factors before deciding to dish out a loan. Many of these factors are related to two aspects of your life and potential business purchase: personal and business finances. Your personal finances include aspects of personal life and decisions such as credit score, outstanding debt, tax returns, and cash flow statements. Business finances include the finances of any prior businesses a person may own, as well as the finances of the business they hope to acquire. These finances include breakdowns of profit margins, balance sheets, and business tax returns. Much of the information that lenders consider at contained within, if not linked to, aspects of the business plan.

Written by Brian Kennerly, Pennsylvania SBDC Lead Office Marketing Team

Brian Kennerly is currently a Graduate Assistant at Kutztown University of Pennsylvania while pursuing his Master’s in Business Administration. His hometown is Upper Darby, PA, and he attended the University of Virginia for his undergraduate career.