How to Finance a Business Purchase

Some people start their businesses entirely from scratch. However, a significant number of entrepreneurs take another route: buying an existing small business. This can be the right move for many reasons — for instance, existing businesses may already have infrastructure in place such as logistics, manufacturing, and staff; they may also have an established customer base you can connect with right away. 

If you are interested in purchasing a business, you’ll need a way to finance your transaction — regardless of its size. There are many avenues to financing, and it’s important to understand the wide range of options so you can pick the best source of funding for your specific purchase. The good news? If you are acquiring an existing company rather than building a business from the ground up, you may find it easier to source funding. 

Personal Funding

The most straightforward approach to financing a business purchase is through personal funds. If you have the means to finance the purchase privately, this can save you money on interest as well as time spent going through the lending process. This funding generally comes from liquid sources such as bank accounts or brokerage accounts.

Of course, not everyone has the means and liquidity to make an acquisition through personal funding — and even if you’re able, it’s important to carefully review your finances on the whole and consider whether you should put your personal funds at risk, before going through with your privately funded transaction.

401(k) ROBS (Rollovers as Business Startups)

If you’d like to finance a business purchase with your own money but don’t have the requisite liquidity, you can look elsewhere: your retirement savings. 401(k) ROBS stands for Rollovers as Business Startups. In short, it enables you to tap into your retirement funds to start or buy a business. In the U.S., if you withdraw money from a tax-advantaged retirement account before you turn 59 and a half, you’ll incur fees — income tax as well as a penalty for early withdrawal. With ROBS, however, you can avoid these penalties and use the money in your 401(k) to acquire an existing business. 

This capital is, of course, yours — you won’t pay interest on it like you would a loan. There’s also no debt or impact on your credit, which can be a huge advantage to a new business owner. However, financial professionals recommend choosing this approach with caution, since you also want to make sure you can support yourself personally in your retirement years and have enough of a cushion to do so in case your business is unsuccessful.

Home Equity Loan

If you feel comfortable leveraging your personal assets to finance a business purchase, you may consider a home equity loan. These loans can be advantageous compared to other types of business loans, since they often come with lower interest rates. While this is an advantage, remember that if your business fails after its acquisition and you’re unable to pay back your loan, your personal home is at risk.

Friends and Family Financing

Another option for private business financing is to raise funds from friends and family. Similar to raising money for starting a new company, friends and family financing can either be arranged as a loan on your terms or in exchange for equity in the company (read more on equity financing below). 

It’s strongly recommended that you put the terms in writing — or even work with a legal professional — instead of operating on a “handshake deal.” It’s also important to remember that bringing personal relationships into business can be tricky, so be prudent when considering this approach.

Small Business Administration (SBA) Loans

One of the most popular and advantageous ways to finance a business purchase is through Small Business Administration (SBA) loans. These loans, generally facilitated through banks and credit unions and backed up to 85% by the U.S. Small Business Administration, have high capital amounts, low interest rates, and long repayment timelines. For entrepreneurs acquiring existing companies, these loans can finance up to 90% of a business purchase price. The most popular programs among these are the SBA 7(a) loan for general working capital and the SBA 504/CDC loan for commercial real estate.

Importantly, while there are technically no written requirements, only candidates with strong credit history will qualify for these loans and they do require a 10% down payment from the applicant. Their application processes are also extensive, and they have long timelines for approval — generally a minimum of three months. Buyers without solid creditworthiness or commercial history may need to look to alternative funding sources to finance a business purchase.

Traditional Bank Loan

When you hear the words “business loan,” you’re likely thinking about a bank loan. These business loans are provided through traditional financial institutions such as banks and credit unions and have varying capital amounts, interest rates, and repayment timelines. While these may be favorable compared to other lenders, they’re generally not as borrower-friendly as SBA loans.

While the qualification requirements for traditional bank loans may not be as stringent as those for an SBA loan, financial institutions still cater to candidates with strong financial backgrounds and creditworthiness. A history in business is also a plus. You should also anticipate relatively long application processes and approval timelines here and be prepared to provide collateral (and in some cases, a personal guarantee and lien). It can be helpful to have an existing relationship with a bank before applying to improve your odds.

Online Lenders

An alternative to traditional banks, several online lenders have emerged as excellent sources of business capital, including to fund acquisitions. 

The upside: the wide range of lenders means they are generally not as difficult to qualify for as SBA loans and traditional bank loans, which means they can be significantly more accessible to entrepreneurs who are just getting started. The downside: their terms, including interest rates and repayment timelines, are not nearly as favorable, and capital amounts are often smaller.

Seller Financing

If you’d prefer not to go through a conventional lender of any kind, you can also explore seller financing. With this arrangement, the entrepreneur acquiring the business works with the current owner and asks for a loan from the buying price (generally 5% to 25%, though this will vary on a case-by-case basis). The borrower, in turn, will pay the money back over an agreed-on period of time.

As this type of financing is under the jurisdiction of the existing business owner, its accessibility will vary. Unsurprisingly, it will help if you’re in good financial standing personally or with other commercial endeavors, as sellers will want to mitigate their risk as much as possible. 

Leveraging Assets

Also called a “leveraged buyout,” leveraging assets can be an excellent way to finance a business purchase for entrepreneurs who don’t have the required cash for a full down payment on their acquisition. In this setup, the borrower leverages a financial asset of the acquired business — for instance, its future cash or its equipment — for the capital.

This may sound like an easy approach, but there are caveats to this type of business financing. First, the assets the borrower is leveraging must be considered valuable in order to secure the loan, and the lender must deem the business viable in the future — in other words, the lender must be confident the business will continue to generate revenue (this is why this type of financing is best for companies with a history of consistent, predictable cash flow). 

Equity Financing

Equity financing has become an increasingly common way to finance businesses, be they startups or acquisitions. With equity financing, entrepreneurs raise funds from private individuals or pools of investors in exchange for a percentage of equity (ownership) in the business. The amount of ownership stake an investor will take as a condition of providing financing is entirely dependent on the agreement between them and the borrower acquiring the business; as expected, the higher the amount, the more equity the lender will expect.

Existing businesses with a strong track record and reputation will be more likely to secure equity funding. It can be helpful for the entrepreneur acquiring the business to have a strong business plan to present to potential investors and they should be prepared for the investors to perform due diligence on the business’s existing financial situation and projections.

Final Thoughts

Acquiring an existing business is a big decision, but one that pays off for millions of entrepreneurs. While it can be a more strategic choice in many scenarios, since you may be able to hit the ground running, it often requires significant capital. However, there are plenty of sources for financing a business purchase, whether you choose to do it through personal means, via investors, or through other types of lending. 

As with any type of business loan, the better your credit history and personal financial standing, the more options you’ll have and the less expensive your financing will be. At the end of the day, lenders are looking for the lowest-risk candidates who are most likely to repay their debts.