BizQuest's Business for Sale Blog

Getting the Money from Family and Friends When Buying a Business

Getting the money to buy a business is, oddly enough, one of the things that many buyers leave for the last minute. Perhaps it ties into the incorrect perception that traditional lenders have their vaults open ready to hand over money to you to buy a business.

Unfortunately, it is not the case. Not even close!

Today, I received an email from a website visitor explaining he has found a business, negotiated the deal and now is absolutely stunned and stuck to learn that his “investor”, his Uncle Max, doesn’t want to lend him the money.

This financial backer initially told him “I will lend you the money – don’t worry” (I really wish they had read my course because here’s what they would have learned):

If you are planning on having friends or family members finance your purchase, you need to understand it is a business deal. More importantly, you must be sure that they will be there to write the check when you need it. It is very easy for somone to off-handedly promise you the money, but it is a whole different ballgame when the time comes for them to fork over the cash.

If you are considering getting financing from your “Uncle Max”, keep a few things in mind:

• Make sure Uncle Max’s criteria for agreeing to finance you is completely aligned with the type of business you are looking to buy.
• Nail down the deal details with your financier before you begin negotiations with any seller.
• Lay out very specifically what Uncle Max expects in return for his investment. Is it equity, debt, and what are the note terms, etc.?
• Involve him in the process. Keep him updated. Analyze companies together. If a particular business is not of interest to Uncle Max, you want to know it early on.
• Be completely upfront with any sellers or their brokers about the source of your financing. Simply telling them “My Uncle Max has plenty of money and will finance the deal” is not good enough.
• Get Uncle Max to provide you with a letter acknowledging they will assist in the financing, and have him provide you with a Personal Financial Statement that you can offer sellers as proof to back up your claim.

While family and friends who offer to lend you the money are well-intentioned, and may even come through with the financing, do yourself a favor and don’t put your entire future in Uncle Max’s hands. There are many options available to finance a business. Learn what these are beforehand. When the right opportunity arises, you want to be in a position to pounce on it and get it done!

I will be leaving for Canada on a personal matter as my father is quite ill. The beauty of my business is that I can operate it from anywhere. However, I am not certain when my next posting will appear, but I do hope to be back on track for the newsletter after Memorial Day. As you may have read in some of my posts last year, I became an American citizen on January 23, 2007 which was one of the greatest days of my life. I waited ten years to achieve that incredible honor. I love this country, and I am totally excited to vote next November. As we “celebrate” Memorial Day, I hope that you too will recognize the day for what it is supposed to be – to honor those before us who gave so much, and paid the ultimate price, so that we can enjoy our freedom. One of my true life heroes is Jerry Efros, who works with Transworld Business Brokers in Fort Lauderdale, Florida. Jerry is a highly decorated WWII veteran and each year, on the Thursday before Memorial Day, I look forward to his sobering, yet somehow uplifting recollection of his military career, and his 33 combat missions as a B17 tail gunner. His stories are bone-chilling. Jerry definitely does not see himself as a hero - he always tells people "the guys that never made it back - those are the heroes." While Memorial Day seems to have unfortunately evolved into a mass retail marketing event, please be sure that you take the time to honor the day and its true meaning. Regardless of your political beliefs, the fact remains that far too many of this great country’s finest young men and women are stationed away from home today and sacrificing their lives for us, just as others before them have done.  Give them their due. We owe it to them. To my friend Jerry Efros, a real American hero, you definitely symbolize the greatest generation - God Bless You!

Loans Come With a Catch...ALWAYS!

I received an email this week from someone who is in the throes of a negotiation for a small food service business. He came across the Diomo website (www.diomo.com ) while searching business listings and sent me a question (I am always happy to answer these so if you have any questions, contact me). He and the seller have settled on a $600,000 purchase price. Deal terms are $200,000 down and the seller has agreed to carry a $400,000 note over 6 years at 9%. Sounds good so far, doesn;t it?

I can't state whether it's a good business to buy because he omitted too many details, except that the company has experienced consistent revenues and Owner Benefits in the $200,000 - $250,000 range over the past three years. At face value, it looks very good but here's the problem: the seller wants the buyer to personally guarantee the note and the buyer steadfastly refuses to do so. The business has zero assets except inventory and some office equipment.

I think the buyer was shocked when I sided with the seller. Providing a personal guarantee is reasonable, normal, and expected. You cannot expect a seller to finance any part of the sale, let alone 2/3 without some assurances.

In this case, there is no personal collateral being pledged. On this point, you should not pledge personal collateral in a seller note; the assets of the business are enough. However; executing a promissory note including a personal guarantee makese perfect sense.

As a prospective business buyer, you must get comfortable with this concept. Just as you want the seller to have "skin in the game" by providing financing, so too must you offer some exposure for this to happen. Besides, a personal guarantee while not to be taken lighly, is by no means bulletproof for the holder of the note. Chances are if you cannot make the payments, the business must be faltering badly. In all likelihood, the seller's best recourse would be to take over the business.

I don't want to be the conveyer of doom and gloom. Good business, run by the right people, rarely fail. That is not the point of this posting. Rather, I want you to understand what you can expect in a seller note and rest assured, a personal guarantee to a seller is almost always infinitely more lenient that what most SBA backed loans require (rumor that the bank wants your first-born has neither been proven or dispelled).

How To Get Business SBA Approved - Doing so as a seller can help make your business more attractive to buyers.

Question:
How do I get my business SBA approved? It seems like doing so would help to move the sale of my business faster. Thank you.

Answer:
This is a great question and you should be commended for being proactive about the financing portion of selling your business. The process is actually quite simple: if you engage a business broker, this is something they can do on your behalf. If you are selling the business on your own, then you should contact a local Preferred SBA lender. They will provide you with a list of documents required to complete the pre-qualification process. These will generally include:

• The most recent three year’s of company tax returns
• Accompanying P & L statements and Balance Sheets
• Your W2
• Recent interim statements
• Asset list

From this they will determine if, under the right deal terms, the buyer will qualify for the SBA program. Plus, there will be some additional conditions relative to the buyer qualifications. They will be able to determine how much they are prepared to lend, what amount the buyer will need as a down payment, what amount (if any) they may ask you, the seller, to finance, and the fees involved to complete a transaction.

Keep in mind that this step is only a pre-qualification and, like all lenders, they will have plenty of disclaimers. However, once you obtain a pre-qualification status, it will provide you with a huge advantage when advertising your business. Make certain that you do not make any claims to prospects about the financing. This is only an initial pre-qualification.

Determining How Much Business You Can Afford - Exploring SBA financing options

Question:
I am interested in buying a business that is for sale for $2 million, with annual earnings of $500k. I am planning to use $500k in home equity for the purchase, but the seller is not willing to offer financing. What are my odds of being able to come up with financing for the $1.5 million balance? I'm told the SBA is my best option.

Answer:
Although I do not know many of the additional details regarding this business, it is likely that your best option will be an SBA backed loan through a traditional lender. While the SBA itself does not make loans, they guarantee up to 75% of a loan that a traditional lender will make under the SBA's 7(a) program. The maximum loan amounts change periodically and today they're at $2,000,000 which works well for your situation.

As I'm sure you can appreciate, there are numerous conditions attached to SBA loans and some points to note about them which are as follows (see also the SBA website: http://www.sba.gov/financing/sbaloan/7a.html)

• The business must demonstrate that it can support the debt based upon prior year's tax returns.
• The buyer's required down payment can vary, but generally is around 20%.
• Recently, a number of SBA deals I have been involved with require the seller to participate in the financing as well for around 10% and be in second position to the bank.
• The SBA wants to have as much security as possible for the loan through a combination of the business' and your personal assets.
• Loan fees are quite steep; however, the SBA will finance them over the term of the loan (how nice!). Nevertheless, the fees are generally meaningless relative to getting the financing and completing the acquisition

 

There are number of articles in the buyer section of this website that deal with financing a business purchase, SBA loans and other options. It is well worth you reading them all.

How to finance Goodwill? - Other than seller notes, what options are available for financing Goodwill and non-tangible assets?

Question:
What options are available for financing "goodwill", other than seller notes? How do you finance the business' non-tangible assets?

Answer:
In many cases of small business acquisitions Goodwill does represent the greatest asset value. Traditional lenders will almost always want their financing to be secured by a combination of business and personal security. As such, for the business you described, chances are that everything will be dependent upon your credit worthiness and the available personal security you have to collateralize the loan.

Most prospective business buyers are not in a position where they can secure a note. That's why seller financing is your best and sometimes only viable option.

There are of course other sources for financing such as venture capitalists or angel investors; however, they usually don't get involved in small business purchases. As with family/friends, good luck...it's usually the quickest way to make enemies.

Should Buyer Use Home Equity to Buy a Business? - Buyer's wife is apprehensive about mortgaging house to buy a business. Should buyer look for other financing alternatives?

Question:
I have found what I believe to be a wonderful business but there's one problem: I really do not have the necessary money for the down payment. The asking price is $650,000 and the seller will finance $425,000 to a 'qualified buyer'. I only have about $100,000 available in cash. The seller and I get along very well. I have about $200,000 in equity in my house but my wife is very apprehensive about getting a second mortgage. The business makes about $250,000 a year. What would you do?

Answer:
I don't think your wife is going to like my answer so let's first examine the alternatives. Assuming that you have checked the business as thoroughly as you can at this stage, and it meets your criteria, then it is certainly worth exploring several scenarios:

Getting the seller to finance more:

Have you discussed this possibility with the seller? Although they are financing a substantial portion, perhaps you can explore this option with them and even consider using your home equity as a partial guarantee on the additional financing that they are currently offering. As an example, you now face a $125,000 shortfall. If the seller would considering financing this portion, they could get a second lien position on your home as security for this amount which would still leave you with $75,000 in equity and the financing you need.

SBA Loans:

If the historical financials can support the debt, this seems like an ideal candidate for an SBA backed loan. While there are certain criteria that need to be in place for both the business and you, at face value it would seem to meet these. Furthermore, it is well worth you exploring this option. Based upon the SBA and lender guidelines, you have what is needed for a down payment under their general guidelines, and with seller financing in the deal it will bridge any gaps that may exist. I would recommend that you contact a local Preferred SBA lender and discuss the deal with them.

Mortgage the House:

Even though your wife may not be crazy about this idea, it is a solid fall back plan should the two scenarios noted above not materialize. While I do understand your wife's concerns, it is critical that she is 100% on board with this decision. Although you are buying the business, she's in this as well. From a financial perspective, the potential return that you can make on your investment by utilizing your equity to acquire the business and generate an excellent income, is far superior to other investment vehicles. Nevertheless, it is something for you and your wife to discuss. Personally, I always like to leave the home out of an acquisition unless it's my only option but I would always be prepared to do so if the opportunity makes sense.

Will Seller Financing Be Second Lien Holder to SBA Loan?

Question:
I have a business financing question. Let's say I want to buy a business that has a sales price of $230,000. The seller is offering seller financing of $130,000, thus all I need is a $100,000 down payment. My question is: can I get a SBA loan requiring 30% down for the $100,000 down payment (thus requiring a $30k down payment versus $100k)? Or would the seller have a problem with this since he would in effect be the "second lien holder"?

Answer:
A lot depends upon the individual seller. In many cases where an SBA backed loan is involved, the seller also participates in a percentage of the financing and clearly understands that they are in second position. However, in these cases the seller is usually on the line for only about 10 - 20% of the total purchase. In the case you cite the seller will be on the hook for 56% with zero security. If you are putting down only $30,000 for a $230,000 purchase price it may not meet the SBA guidelines either as borrowers under their 7(a) program are generally required to contribute a 20% down payment.

I think this may be the bigger issue. As well, the SBA backed loans require specific personal guarantees and collateral between the business and the borrower. While I think the terms with the seller may be flexible, you won't have the same wide parameters with the SBA program.

Although there are some very attractive components to an SBA deal such as a lower interest rate and longer term, the downside is the personal collateral they require. With a seller loan, while you will sign personally, their lien is against the assets of the business. In your situation, I would certainly recommend discussing this with an SBA preferred lender; however, if you have ample capital, you may wish to negotiate a bit more with the seller.

Does SBA Look Favorably on Industry Experience?

Question:
I have worked in the childcare industry for many years. I am now interested in purchasing a day care center. I have found a center I wish to purchase in another state. Because of my 25 years of managing day care centers, will SBA look favorably in trying to obtain a loan with me as a semi-absentee owner?

Answer:
Excellent question! The SBA requirements have become far more rigid in the past few years regarding the borrower's prior experience to be certain they have the background to operate the business. In fact, a senior executive at an SBA preferred bank told me that an SBA audit two years ago determined that a lack of relative experience by borrowers was the single biggest factor in bad loans. Since then they have tightened up their requirements and rightfully so.

In your case, there is no doubt that your past experience is an excellent fit for the type of business you are looking to pursue. However; there may be concern if you do not intend to be the full time operator. This is something that you will want to discuss with the individual lender as their specific criteria may vary. Personally, I think you are far better off to operate the business full time for at least the first 6 months and then consider hiring a manager.

As you probably know, the SBA does not lend money. They simply guaranty a portion of the loan made by lending institutions. While there are specific SBA criteria so too will each lender have its requirements. That's why you may need to approach a few different SBA lenders. On this point, try to work with a "Preferred SBA lender", as they can process your loan quicker and more efficiently.

If you'd like to learn more about the SBA's 7(a) program, here's a link to their website: http://www.sba.gov/financing/sbaloan/7a.html

Using IRA to Buy a Business

Q: I am currently in escrow to buy a service business and I recall one of your articles indicating that a valid exception for IRA use is to buy a business. Is this the case and where can I find the IRS code for this?

A: I believe it's IRC 4975d(13) and ERISA 408e

Financing for a Small Online Business

Q: I'm interested in buying a small but profitable online business. I would need to get an SBA loan to finance the purchase. The problem is that the business has only been in operation for about 9 months. Also, being an online business, it doesn't have any tangible assets. Do you think I will be able to get an SBA loan given these factors?

A: Pardon my bluntness: No way! Sorry. The SBA 7(a) loan guarantee program includes specific financial requirements that the business must meet which this business does not satisfy. Most specifically, they require at least two years of tax returns to verify the financials. Insofar as assets are concerned, this is less of a worry as these loan programs require personal assets (i.e. home equity, marketable securities, real estate, etc) to guarantee the loan. In any event, the SBA is not the way to go on this deal.

However, this does not mean that the deal can't be done. Any seller of a 9 month old business has to understand that they will be required to provide financing for the deal or offer a significant discount for an all cash purchase. If this particular seller is not flexible in his/her terms, then chances are they will not sell the business, or they may sell to a very uninformed buyer.

Need Financing But Seller Has Not Reported All Income

Q: We have $40,000 to start a new business. But the business we want costs $200,000. The actual owner is not reporting the exact amount of money that the business produces. How can I convince the SBA to give me the loan? Our credit is perfect and we own 2 houses.

A: Thank you for your inquiry. First let me clarify one thing: the SBA does not lend money. Rather, they guarantee a certain percentage on loans that traditional lenders may make for small business acquisitions. That being said, there are two fundamental aspects to the requirements of an SBA loan. First, the business itself must qualify. Second, the buyer must qualify from a credit, experience, and guarantee standpoint.

It sounds like you may meet the requirements; however, the business may not. For the business to qualify, the lenders use a formula based upon the prior two to three years of tax returns, reducing the Seller's Discretionary Cash Flow by an adequate wage amount for the new owner. Then they calculate the debt service to be certain the business can afford the payments. If this seller has not been reporting the total revenue, the business may not have enough demonstrative proof of being able to service the debt. If that is the case, you should pursue a seller financed deal. Notwithstanding this, it's well worth you meeting with a "Preferred" SBA lender to discuss the deal. At the very least, it will show the seller the challenge that every buyer will face who does not have more liquid cash to use as a down payment.

This situation is a perfect example of how business owners quite often only fool themselves by not maintaining clean books and records. Generally, any undisclosed income pales in comparison to what they would get when they sell the business if they handled all transactions legitimately.

Overview of Seller Financing

Q: Can you explain how Seller Financing is typically handled in a deal? I'm in negotiations to buy a business now, and I want to make sure this is included, but I'm not sure how much to ask for or what terms.

A: You raise a very good point. While there are no hard set rules regarding seller financing as a percentage of a deal, one thing is clear: it's a critical component to any deal. First, it serves to validate all of the representations and claims that a seller may make about the viability of his/her business. Second, it's far easier to arrange seller financing than it is to obtain bank or SBA backed financing. Third, it's an accepted practice. Lastly, it will allow you to leverage your cash down payment.

Having said this, my recommendation is that you target your offer to include 40-60% of the deal as seller financing. In today's market, the interest rate should be around 6 - 8%. More important than the rate is the amortization schedule. The longer you can negotiate to payoff the loan, the easier it will be on the business. As such, you're better off to give in to a higher rate, in exchange for a lengthier period. As a barometer, 5 - 7 years should be your target, at least in the initial offer.

Here are some of the additional terms you may want to offer:

• Retain the right to payoff the loan early without penalty.
• Make lump sum payments towards the principal once per year.
• There should be no payments for the first 90 days after closing.
• The first year should be principal payments only.

As a last point, after you own the business for a while if you have excess cash, you may want to consider offering the seller a discounted price to pay off the entire loan. In this case, you should get at least a 20% discount on any outstanding balance. If the business is doing well, call the seller and offer to pay off the whole note. Chances are you'll hear them starting their car during the conversation.

Using 401k or IRA Funds to Purchase a Business

Q: I am looking to purchase a business, and I found a company that is offering to use my 401K and IRA funds to set up the company. It sounds like a good deal. Do you have any information on this type of business?

A: I've read all about them and in theory it seems like a brilliant deal. I have not done this personally but I do know from speaking with professionals that it's not simply a generic program applicable to every situation. I am ALWAYS wary of these so called "loopholes". The key is that the plan itself and the transaction must be set up and completed precisely. As such, I would suggest that you have your accountant and/or attorney review this possible option for you.

Alternative Financing Sources

Question:
I have owned and operated a Domino's franchise for five and a half years and now I have found an under-priced pizza restaurant in Hawaii. The problem is due to certain events I obtained a lot of bad marks on my credit report, which was great five years ago or I would not have gotten a loan then. I have never been late on an SBA payment or to the bank. How can I get the needed $50,000 start-up capital? The owner has agreed to finance another $20,000.

Answer:
You have a number of options available to you, but first I want to understand if you have any available capital at all? You have to approach this deal with the realization that you do not have a lot of leverage financially. The only factor in your favor is that the business is being sold at a discounted price. Therefore, you must prepare a proper presentation to potential lenders that outlines this facet very clearly.

For purposes of this answer, I shall assume not. The most logical place for you to go first is the bank that financed your Domino's business. They are the ones with a history on you. Second, should that fail, is to approach anyone or institution with whom you've had a successful financial relationship. Next, any possible personal friends/family members who youcould bring on as a silent partner?

Should you exhaust all of these avenues without any luck, then the seller in Hawaii is your only resource. Since this business is under-priced to begin with you should approach him/her with two deal scenarios:

• To buy part of the business now with an agreed upon buyout over the next 2-3 years at a pre-determined formula thus lowering the amount you need upfront.
• Pay them more than their asking price but have them hold a larger note. If the business is priced below what you believe it should be, then you should have no problem paying them more if they're willing to finance more.

Can I Qualify for an SBA Loan with a Bankruptcy?

Q: I have a question about SBA qualifying: 3 years ago I sold a very successful post production business. The sale was due to a horrific partnership. The buyers bankrupted the business and I never got released from my largest debt, which was about 700,000. In the end I had to claim bankruptcy. What are my chances of getting an SBA loan for another business and what will it take for me to convince them that I can do it again?

A: I'm sorry to hear about your past experience and I won't spend any time discussing what you could have done differently; I'm sure you've beat yourself up enough already and I have the world of admiration for you for dusting yourself off and not being deterred. You are a true entrepreneur and you will succeed! I wish I had good news for you with potential lenders. From my experience, a bankruptcy will all but nullify your qualifying for any type of SBA or traditional bank type loan.

However, this should not preclude you from being able to acquire a business. Your best option, without question (and one I always recommend even if you have flawless credit) is to negotiate seller financing. It may not be available in every case. It may require you to search a little longer, but I promise you that these deals are done everyday and in the vast majority of cases. In fact, without trying to sound like an infomercial, over 90% of our clients negotiate seller financing. This is undoubtedly the tact I would take in your situation. Get back into business. Negotiate the best deal possible. Build your business again and improve your credit. Once you do, the lenders will be banging down your door but then again, you may never even need them!

Bad Credit, No Money, and No Experience

Question:
Hi I have really bad credit and no money at all to invest. Do you think I will be qualified to open a small business? Also I don't have any experience.

Answer:
I am a firm believer that anyone who has a burning desire to be in their won business can do so successfully. However; I don't want to give you any blind or unrealistic advice. The chances of you buying a well performing existing business are slim because it does take money. Perhaps, it may make sense for you to start up a small venture to, at the very least get a flavor for what is involved day to day in operating a business. The entire key to your success at this point is education. You have the ambition, but simply lack the "know how".

If I were in your position, I would consider dedicating a year or two to acquiring the business skills needed. You may want to look to get a job temporarily where you can work alongside an entrepreneur and absorb as much as humanly possible. Having said this, you should also know that operating a business successfully is not the most difficult thing in the world. Personally, I think keeping a boss happy is a lot harder.

Above all, do not give up. When I began on my own 14 years ago, I had no money (actually I owed $60,000), and I did not go to any fancy college. In fact, I didn't even go to college. But, I was ready to do whatever had to be done to be successful. This included taking night courses, devouring every business book I could find, associating myself with winners, and getting up everyday with one goal: do better than I did the day before! I hate to sound like a wild eyed motivational speaker but the results are there. Since then, I've bought ten businesses and sold nine and have been successful beyond my wildest expectations. I guarantee that it can be done.

Using 401k or IRA to Buy a Business

Question:
Can a person use 401k assets or IRA self-directed assets to purchase a business, without tax implications?

Answer:
There are a number of programs available now that offer this type of scenario. Personally, I have not used this route but if the programs work as fluidly as they are presented to be, this can be a tremendous option. While you absolutely must have your attorney and accountant review any such deal, you may want to check out:

http://http://www.bizquest.com/resource/benetrends.asp?source=BizQuest

Apparently and allegedly the tax code allows you to transfer money out of a qualified retirement plan to purchase stock in your own business. Since no "rollover" takes place, there is no taxable event. Once again, I must stress that you have this verified by a professional.

Using House as Collateral for Bank Loan

Q: I am purchasing a business with a successful 10 year track record. Purchase price is $2.8M with seller financing of $1.175.  I have found a bank who will loan $975K but they want my house as collateral.  The business has assets (no real estate) of approx $1.5M (600K inventory + 900K FF&E). While I intend to go forward, I was wondering about the potential benefits of refinancing with someone who would not require my house as security? When could you do this and with whom (SBA)?

A: Unfortunately, when it comes to bank financing, they want bulletproof collateral and not the business' assets. Under normal circumstances I would strongly urge you to avoid pledging your house but this case is a bit different. If I understand the deal correctly, you'll be completing a $2,800,000 acquisition for just 23% of your cash down at closing (the $650k difference between the seller financing and the bank). This is a very attractive deal. While it would be ideal to negotiate this transaction without any personal assets on the line, relative to the purchase price your collateral is not significant. But, the question remains whether there is another way. Some of the "hard money" lenders (those who charge a higher rate) may be willing to do this type of deal. Also, you may want to consider structuring the deal so that they provide you with a line of credit against the inventory portion which is collateralized by the inventory itself and use these funds towards the purchase price.

Also, you may want to contact some lenders and financial groups such as GE Capital who may be willing to buy the FF&E from you and lease it back. Here again you can use the proceeds to fund the purchase. In order to do this in a timely manner, you may need to get the traditional loan, secure it with your home, and have an option for early payment with no penalty and then explore the other options available to you.

Seller Financing

Question:
I am looking at buying a business where the seller is offering 30% owner financing.  How is this typically structured?  What are the standard variables and negotiating points?

Answer:
While seller financing is something you always want in a deal, I would suggest that you shoot for at least 40%. Although deals vary, the note should generally be for five years, at around 6% - 8% with the ability to prepay at any time. I would also recommend:

• Starting the payments 60-90 days after closing with no interest penalty for this period
• Have the ability to pay down the principal sums at least twice per year.
• The loan is to be secured by the assets of the business and no personal collateral (i.e. your house). While you will have to sign personally, do not pledge any personal assets. After all, if the business is as good as the seller has most likely represented it to be, then he/she should have no problem securing his note against these assets.

As a side bar, if the business proceeds well in the future and you can afford it, approach the seller and offer to pay off the note immediately for a sizeable discount (at least 20%).

Alternative Funding Sources

Q: I want to buy a business and I wanted to know if you know any sources for funding? Like grants, lending, investors. I don't have collateral and my credit score is not established enough for a loan.

A: Unfortunately, buying a business is not like the infomercials you see with the "real estate for zero down" promise. Depending upon the industry you're looking at there may be some local government grants that can assist you. To this end, you may wish to visit with your local SBA or SCORE office, and also speak with some local banks to see if there are any programs in place that may offer assistance.

Financing a Business Purchase

Q: I have very little in the way of capital, other than home equity, to invest in a small business. I want to buy a small business but don't want to use home equity, which will be used later to partially finance my kids college education. What other sources of financing are available and which is the best?

A: Unfortunately, buying a business is not like the "no money down" real estate infomercials you see on TV. You will need to fund the down payment at the very least. Your best option will be seller financing and in the best case scenario, this can be around 50% of the purchase price. Surely there are cases where the seller may finance more, but it's rare. I fully understand your desire to not leverage any of your assets and I'm definitely not an advocate of being reckless. But, if you're not willing to leverage your assets such as your house on a business that you believe that you can grow, then chances are that the particular business, or business ownership itself, may not be for you.

Buying a small business requires some risk. Clearly, with the right information you can dramatically reduce the risk and eliminate the guesswork. But, entrepreneurship requires you to bet on yourself. You need a burning desire to succeed and belief in yourself to do so. You'll find that the most successful entrepreneurs have all put it on the line at some point to be where they are today.

Financing a Small Restaurant/Cafe Purchase

Question:
I have been searching for about 6 months for a business. I have looked at some deli / cafes and restaurants, but have found that banks do not want to finance these types of businesses. Some of these businesses are long standing and reputable. Why is it so hard to find financing? What type of businesses do banks like to finance?

Answer:
Banks do a wonderful job of promoting themselves as "small business friendly". Their ads give the impression that their vaults are open for entrepreneurs. This is definitely not the case when it comes to small business acquisitions. Yes, they will lend you money, as long as you can fully collateralize it with hard, personal assets (not the business). This is especially true as it relates to restaurants and cafes for several reasons: first, these businesses typically have lots of unreported income and so there are no financials available to substantiate the seller's representation of what the business generates in sales or profits. It's also the reason why restaurants typically sell at lower multiples. It's nearly impossible to find this type of business where it's all on the tax returns. Second, the failure rate in restaurants and cafes is enormous. It's been estimated to be as high as 90% in the first year. Banks don't fund risk, and< these are very risky businesses.

What do banks like to finance you ask? Generally, they want businesses that are asset rich. But, even with those, when it comes to small businesses they want their funding collateralized by the owner and not just the business' assets. This even holds true for SBA backed loans. Their standards are very rigid in this regard as well. You should also know that seller financing is very much the norm in restaurant purchases and that is the strategy you should follow.

Adding Back Owner Benefits - Depreciation and Interest Expense explained

Question:
I have a question about Owner Benefits when they "add back" certain expenses. Why does Interest and Depreciation become "cash flow to owner/Owner Benefit"? I understand why the owner's salary that's considered "excessive" and Net Income do but Depreciation and Interest are part of what makes up the Net Income. How is it that they get counted again (added back to get the Owner Benefits?)

Answer:
Depreciation is non-cash expense. It's included solely for accounting and tax purposes. Example: the business owns a truck and they paid $20,000 for it and there is an estimated useful life of five years. Each year they can deduct (depreciate $4,000) of it for tax purposes. While it reduces the tax burden the fact is that it's not an actual outflow of cash. As such, it's added back to the Owner Benefits.

However, any Depreciation that you add back must be offset by any amounts you will need to annually set aside to replace these assets. If you're looking at a capital intensive business, you cannot add back the entire Depreciation amount, and remember to allocate a certain amount regardless of the depreciation add back for your future capital expenditures.

Interest Expense is a function of the capitalization of a business and can vary widely from one owner to another. Example, you may run the business entirely off the cash flow and decide to not obtain any additional funding therefore there won't be any interest expense. On the other hand, if there are any loans to the company which you will assume after closing then of course you have to factor the interest as an expense. Generally, these loans are paid off at closing by the seller from the proceeds of the sale as such any future interest will be dependent upon your business not theirs.

The Pros and Cons of SBA Loans - This government organization may fit your needs under the right situation

Question:
Can you provide an outline on SBA loans and advise the pros and cons of it?

Answer:
By the time you read this, the SBA may have changed the rules! While the SBA has some attractive features, here are a few key pointers:

• The SBA does not lend money. It guarantees loans for small business acquisitions (7a loans) that are then underwritten by traditional banks.
• Fees are high. I was recently involved in a transaction whereby the loan amount was $1.33 million and the fees to the buyer were over $40,000 BUT, the SBA will lend you the money to pay these (isn't that nice of them?).
• The maximum loan amounts vary depending upon budgets. As of today the maximum is $2,000,000 including real estate. Government fiscal budgets end September 30th every year and programs get shut down as the date approaches. Sometimes they'll alter the program (or even shut it down temporarily) during the year, so get your paperwork in quickly.
• Use a "preferred SBA lender" bank. They can process and pre-qualify the loan in house.
• The business itself must qualify based upon 2-3 years of tax returns. The lender will generally take the worst year and calculate the total cash flow. Then, they will deduct a reasonable salary for you the owner. The remainder is subject to a formula (usually divided by 1.2) to determine the remaining cash flow to see if it can service the debt load.
• You'll have to demonstrate to the lender that your background is suited to run the business. Prior failures were directly attributable to the buyer not having the right experience and so they are far more rigid on this aspect now.
• You WILL have to guarantee the loan. SBA lenders are required to go after all available personal assets from the buyer as collateral however; you can get away with about 40%. Yes, they will require your house if you have more than 25% equity.

On the plus side, you can achieve tremendous leverage as the SBA will lend up to 80% (you put up 20% although they're now looking at 70%/ 20% from the buyer and 10% from the seller), they have ten year terms plus they'll also finance any real estate in the deal and blend it with the business acquisition loan for a very favorable term.

Putting up the House to Finance the Acquisition

Q: My wife is flipping out that we are going to have to put up the house to finance the business but isn't there a way for me to buy a business without risking my home? I really don't think I have the stomach for it.

B. Pattison - Omaha, NE

A: I don't blame your wife! Except for very rare circumstances you should not have to pledge your home to acquire a business. Of course, if you go the route of traditional bank financing (SBA or other), yes, you will have to collateralize the loan with assets outside the business. That is why it's so important to negotiate seller financing as part of the deal. First of all, seller financing goes a long way to validate the business, and his/her belief that you can run it.

Next, seller financing is a very normal part of small business transactions. 91% of my clients negotiate seller financing. Plus, a seller should/must accept the business' assets as collateral. After all, they've usually spent considerable time selling you on how wonderful these assets are...right?

Now, you must also realize that you will have to sign personally, and you must be prepared to accept that condition but, no hard personal assets pledged. With seller financing you will have to personally guarantee the loan via a promissory note however the seller's first lien will be against the business itself and then you. Rarely does it ever materialize that a seller comes after the buyer.

Often times, buyers tell me they don't feel they should have to personally guarantee the seller note (obviously if you can negotiate around this, that's great but rare) but I disagree for two reasons: A true entrepreneur is always prepared to put it on the line and bet on themselves to succeed. Second, if you're not 100% convinced that the business is right for you, and will grow substantially with you as the owner, then in addition to your concern about a personal guarantee, you should also think about whether you should pursue the business at all.

The Proper Definition Of A Profit For A Business

Question:
I've just begun to look for a business and I'm a bit confused. My search has been focused with online business for sale listings. Each website seems to have different terminology for the profit of the business.

Answer: Great question! You're correct; there's no uniform terminology for the profit of a business between the various websites. Some may call it: EBITDA (earnings before interest, depreciation & amortization), Cash Flow, Sellers Discretionary Cash, Owner's Benefit, and a few others.

Regardless of the exact term, you'll always want to clarify and reconfirm the information with the seller/broker so that it's perfectly clear what numbers are included in the figure. EBITDA is not really applicable for a small business acquisition where you'll be replacing the owner, as this is simply a financial picture of a debt free business. Personally, I don't like the term Cash Flow -- it's not the same thing as profit, and many people are confused by this.

Cash Flow simply means the cash the business had at the beginning of a period, and what they had at the end, and what happened with the difference. The figure you'll want to determine is Sellers Discretionary Cash or Owner Benefits. This is the Pretax Profit of the business + Owner's Salary/Perks + Depreciation + Interest add backs. Pay special attention to Depreciation, For capital intensive businesses, you'll have to reduce this figure by any amounts you may need to purchase additional or replacement assets in the future.