How to Finance the Purchase of a Business

Few people buy a business with cash alone. Most deals combine several sources of money: the buyer's own savings, a bank loan, money lent by the seller and sometimes outside investors. This guide explains the main ways to finance the purchase of a business, what lenders typically look for and how to build a funding plan. It is general information, not financial or legal advice.

Financing an acquisition is different from financing a startup. With an existing business, there is a track record: revenue, profit, customers and assets that a lender can examine. That history can make borrowing easier than for a brand-new venture, but it also means lenders will test the numbers closely.

The right structure depends on the size of the deal, the type of business, your own resources and what the seller will accept. Loan terms, rates and fees vary widely by lender, country and time, so treat everything below as a framework and confirm current details with lenders and advisers.

Start with your own equity

Almost every financing plan begins with money from the buyer. Lenders and sellers want to see that you are taking real risk alongside them.

• Savings and investments. The most straightforward source, but keep enough aside for personal emergencies.
• Home equity. Some buyers borrow against their home. This puts your house at risk if the business struggles, so think carefully and take advice.
• Retirement funds. In some countries there are structures that let you use retirement savings to invest in a business. They are complex and carry tax and legal risks, so use them only with specialist advice.
• Family and friends. Put any loan or investment in writing, with clear repayment terms, to protect relationships.

SBA 7(a) loans and bank financing

In the US, the Small Business Administration's 7(a) loan program can be used to buy an existing business. The SBA does not usually lend directly. Instead, it guarantees part of loans made by approved lenders, which can make banks more willing to lend for an acquisition. The lender sets the terms within the program's rules, and those rules change over time, so check current details with the SBA and with lenders.

What lenders typically look for

Requirements differ between lenders, but most will examine similar areas:

• Cash flow. Whether the business has historically generated enough cash to cover the new loan payments with room to spare.
• Your experience. Relevant industry or management experience, and your plan for running the business.
• Equity injection. How much of your own money you are putting in.
• Credit history. Your personal and, where relevant, business credit record.
• Collateral. Business assets and sometimes personal assets that secure the loan.
• Personal guarantee. Many lenders require owners to personally guarantee business loans.
• Documents. Business tax returns, financial statements, the purchase agreement, a business plan and projections.

Conventional bank loans

Banks also lend for acquisitions outside government programs, especially to buyers with strong credit, significant equity and solid collateral. In the UK and elsewhere, banks and specialist lenders offer acquisition finance, and some government-backed schemes exist from time to time. Compare several lenders, because appetite for acquisition lending varies a lot.

When you compare offers, look beyond the headline rate. Ask about the repayment period, any fees, prepayment penalties, the collateral required, covenants you must meet each year and how quickly the lender can reach a decision. A loan that closes on time with clear terms can be worth more to you than a slightly cheaper one that delays the deal or adds restrictive conditions. Ask a broker or accountant to help you compare offers on a like-for-like basis.

Seller financing

Seller financing, sometimes called a seller note or vendor finance, means the seller lends you part of the purchase price. You pay a portion at closing and repay the rest to the seller over an agreed period, usually with interest. It is common in small business sales.

If you also use a bank or SBA loan, the lender will have rules about how a seller note fits alongside its loan, such as when the seller can be repaid. Agree these points early so the seller is not surprised later.

Put the seller note in a written agreement drafted or reviewed by a lawyer. It should set out the amount, interest, payment schedule, security, what counts as a default and what happens if you sell the business again before the note is repaid.

Earn-outs and other deal structures

Some deals bridge the gap between what the seller wants and what you can fund or justify through the structure of the payment, not just the amount.

• Earn-out. Part of the price is paid later, only if the business hits agreed targets, such as revenue or profit. It reduces your risk if performance is uncertain, but the targets must be clear and measurable.
• Holdback. Part of the price is held back for a period to cover any problems discovered after closing.
• Consulting or transition agreement. The seller is paid to stay on and help for an agreed period.
• Asset or share purchase. Buying assets rather than shares changes which liabilities transfer and how the deal is taxed, which can affect the price both sides accept.

Investors and partners

If you cannot fund the equity yourself, outside investors may help. Investors usually take a share of ownership and expect a return, and they may want a say in decisions.

• Private investors. Individuals who invest in exchange for equity or a structured return.
• Partners. A co-buyer who contributes money and possibly skills. Agree roles, decision rights and exit terms in a written agreement.
• Search funds. In entrepreneurship through acquisition (ETA), a searcher raises money from investors to find and then buy one business. The model originated at Stanford Graduate School of Business in 1984.

Build your financing plan

A financing plan sets out where every dollar comes from and checks that the business can carry the debt. Work through these steps with an accountant.

1. Add up the total cost. The purchase price, working capital, closing and professional fees, and any immediate investment the business needs.
2. List your sources. Your equity, bank or SBA loan, seller note and any investor money.
3. Calculate debt payments. Work out monthly or annual payments for every loan and seller note.
4. Test the cash flow. Check that the business's cash flow covers all debt payments and your salary, with a margin for a weaker year.
5. Stress test it. Model what happens if revenue falls or costs rise. If the plan only works in a good year, it is too tight.

Frequently asked questions

The bottom line

Financing the purchase of a business usually means combining your own equity, a bank or SBA 7(a) loan and seller financing, sometimes with earn-outs or investors. Prepare your documents, understand what lenders typically look for and make sure the business can carry the debt comfortably. Loan programs, rates and rules vary and change, so confirm current terms with lenders, official sources and a qualified adviser before you commit.