Business Acquisition Loans: What Are They & How They Work?

Acquiring an established business presents an exciting opportunity for entrepreneurs. Whether you’re looking to buy a franchise, purchase a well-established company, or acquire a partner’s stake, securing the right financing is essential. One of the most popular methods for funding these types of acquisitions is through a business acquisition loan.

What is a Business Acquisition Loan?

A business acquisition loan is a financial resource designed to assist entrepreneurs in buying an established business. Whether you are buying a franchise, a business partner’s share, or the assets of another company, these loans provide the capital necessary to close the deal. The loan can cover various aspects of the acquisition, such as purchasing inventory, equipment, or real estate, and it may be provided by traditional lenders, credit unions, SBA-approved lenders, or online lenders.

These loans usually come with fixed repayment schedules and interest rates, with the lender specifying how the funds can be utilized depending on the nature of the acquisition.

How Do Business Acquisition Loans Work?

Business acquisition loans are generally offered as term loans, meaning you borrow a specific amount and repay it in fixed installments over a set period. Alternatively, you might use a business line of credit for more flexibility.

Lenders assess factors like your credit score, business experience, and the financial stability of the business you’re acquiring when considering your loan application. The time it takes to get approval can vary based on the lender and the type of loan.

Types of Business Acquisition Loans

Multiple financing options exist for acquiring a business, each offering distinct terms and advantages. The best choice for you will depend on your financial condition and the details of the acquisition.

Bank and Credit Union Loans

Traditional bank and credit union loans are common for financing business acquisitions. These options often provide attractive interest rates and extended repayment terms, though they come with more rigorous eligibility requirements. To qualify, you’ll generally need good personal credit, strong financials, and several years of business experience. Some banks may also require collateral.

However, the approval process can be slow, and not all lenders may offer fast access to funds.

SBA Loans

SBA 7(a) loans, supported by the Small Business Administration, are a popular choice for business acquisitions due to their lower interest rates and extended repayment terms compared to standard bank loans. To qualify, applicants usually need at least two years of business experience, a personal credit score of approximately 690, and strong annual revenue. Some lenders also require a minimum 10% down payment.

While these loans offer attractive terms, the approval process can be lengthy and often requires extensive documentation, such as financial statements and tax returns.

Online Lenders

For those needing quick access to funds or struggling to meet traditional loan criteria, online lenders provide a viable alternative. With more lenient requirements and approval times that can take just a few days, these lenders are an attractive option. Some even consider applicants with credit scores as low as 630 and may not demand physical collateral.

While the convenience is appealing, the trade-off often comes in the form of higher interest rates, making these loans more expensive than traditional options.

Business Acquisition Loan Requirements

When applying for a business acquisition loan, lenders assess a variety of factors to determine your eligibility. Understanding these requirements can improve your chances of approval.

1. Personal Credit Score

Credit scores heavily influence loan approvals and terms. A strong score improves your chances of securing favorable rates and conditions. SBA loans often require a minimum score of 690, while online lenders may consider lower scores. However, maintaining a higher score typically unlocks better interest rates and repayment terms, regardless of the lender.

2. Annual Revenue

Lenders want to see that the business you are acquiring has a strong revenue history, or that your current business is financially healthy enough to support the new debt. A business with solid annual revenue indicates that it will likely be able to cover loan repayments.

3. Time in Business

Lenders prefer borrowers with established businesses. If you have several years of experience managing a business, it can boost your credibility and demonstrate that you can successfully manage an acquisition. However, if you’re new to business ownership, a strong business plan or a larger down payment may help offset this factor.

4. Down Payment

A down payment is often required, especially for SBA loans and traditional bank loans. The down payment is usually between 10% and 30% of the loan amount. Providing a down payment can strengthen your loan application and potentially allow you to secure more favorable terms.

5. Collateral

Certain lenders might ask for collateral as a guarantee for the loan. This could be your business assets or even assets from the company you are acquiring. Offering collateral reduces the lender’s risk and may help you access larger loan amounts.

Limitations of Acquisition Loans

While business acquisition loans can provide the necessary funding to buy a business, they do have some limitations.

1. Strict Eligibility Requirements

Lenders look for good personal credit, solid financials, and business experience. If you don’t meet these requirements, it may be harder to qualify for a loan or you may face higher interest rates.

2. Slow Approval Process

Traditional lenders, like banks and SBA lenders, may take weeks or months to approve your loan. This can be a problem if you need the funds quickly. While online lenders are faster, they may charge higher interest rates.

3. Cash Flow Impact

Covering loan repayments, including interest, can limit the resources available for daily operations and future expansion. This may put pressure on your business’s cash flow, particularly during the initial phases.

4. Down Payment

A down payment, often ranging from 10% to 30% of the loan amount, is usually required. This can pose a challenge if you lack sufficient savings to meet the requirement.

5. Personal Risk

Certain loans might demand a personal guarantee or collateral. If you’re unable to repay the loan or the business doesn’t succeed, your assets could be at risk.

6. Limited Loan Amount

The loan amount is based on the value of the business you’re buying and your financial qualifications. If you need more capital than the loan offers, you might need to find additional funding sources.

Alternative Business Acquisition Financing Options

In addition to traditional loans, there are other options available for funding a business acquisition:

Seller Financing

Sometimes, the seller agrees to provide the funding for the acquisition. This approach allows for flexible terms but requires a strong level of trust and clear negotiation between both parties.

Equipment Financing

If the purchase includes substantial equipment, you can explore loans designed specifically for financing these assets.

Self-Funding

Entrepreneurs with enough personal savings or retirement funds might choose to finance the purchase themselves. While this option avoids debt, it carries a higher personal financial risk.

Friends and Family Loans

Borrowing from loved ones can come with more lenient terms, but it’s crucial to establish a formal agreement to prevent misunderstandings or strain on personal relationships.

Time to Finance Your Acquisition

Selecting the right financing option for your business acquisition is a key factor in achieving success. Familiarizing yourself with the various loan types, their eligibility criteria, and the application steps can greatly influence the ease and efficiency of your acquisition. A clear understanding of the loan terms will help ensure that you are well-prepared and positioned to obtain the necessary funding.