How to Get a Loan to Buy a Business

Check your eligibility

The first step is to check if you qualify. When applying for a business acquisition loan, lenders will assess your eligibility based on several factors.

• Good credit: Lenders will look at both your business and personal credit report and the personal credit of any partners who own at least 20% of the business. Good credit scores indicate you are more likely to repay the loan.

• Revenue and debt requirements: Lenders want to ensure your business generates enough revenue to make the loan payments. They'll review your revenue and existing debt payments to calculate your debt-to-income ratio. A lower ratio is better.

• Minimum down payment: Some loans require 10% to 15% down, while others allow 0% down. Putting down more of your own money reduces the risk for lenders.

• Business plan: You'll need to explain how you'll use the loan funds to buy the business and expand operations. A detailed plan shows the lender you've done your homework.

• Collateral: Lenders may require you to put up collateral, like business assets or equipment, in case you default on the loan. More collateral reduces their risk.

• Experience: Lenders may want to see that you and your partners have experience running a successful business before lending large sums of money.

You can increase your chances of getting approved for a business loan by cleaning up your credit, making a down payment if possible and showcasing your experience with a detailed business plan.

» MORE: Getting a business loan with no credit check

How lenders determine how much you can borrow

To determine the maximum loan amount you qualify for, lenders will look at two major factors:

• Cash flow and earnings: Lenders look at the target business’s cash flow, typically using earnings before interest, taxes, depreciation and amortization (EBITDA) or seller’s discretionary earnings (SDE) to estimate how much debt it can support.

• Debt service coverage ratio (DSCR): This ratio measures cash flow available against annual principal and interest obligations. For example, a 1.25 DSCR means the business generates $1.25 in available cash flow for every $1 in annual debt payments.

What if the loan amount is less than the cost of the business?

If the purchase price is greater than the amount the business cash flow can reasonably afford to cover, you may still be able to qualify for a business acquisition loan by making a larger down payment or negotiating a lower price. Seller financing may also be an option to help bridge the gap.

Choose your lender

If you believe you’ll qualify for a loan, the next step is to choose your lender. There are many places you can turn to for a business acquisition loan.

• Banks: You’ll usually find better interest rates at traditional banks, but you’ll be met with stricter eligibility requirements. Expect to need a minimum 700 credit score, a larger down payment and at least 24 months in business.

• Credit unions: Credit unions often have the same strict requirements as banks. But if you’re looking for a local or member-owned financial institution to do business with, a credit union could be worth exploring.

• Online lenders: If you’re short on time or are worried about your credit, an online lender may make more sense for a business acquisition loan. These institutions provide faster approvals and funding — but they come at the cost of higher interest rates. Because of this, online lenders are better for borrowers with lower credit scores.

• SBA lenders: The Small Business Administration (SBA) provides government-backed loans you can use to acquire a new business. These loans often have longer repayment terms and lower rates, but the approval process is lengthy.

Choose a lender that best matches your credit profile, required loan amount and timeline for funding. Consider these factors:

• Your credit score and history: Online lenders can approve lower scores.

• Loan amount: Banks and SBA loans offer higher amounts.

• Urgency: Online lenders provide the fastest funding.

• Rates and fees: Compare annual percentage rates (APRs) and fees across multiple lenders.

• Loan terms: Make sure the repayment schedule fits your budget.

» MORE: How business loans work

Combining financing sources to fund a business acquisition

It's not uncommon for buyers to combine multiple financing sources to cover the total purchase price, especially when they're looking to ensure they have sufficient cash to operate the business after closing.

Here are commonly used financing sources and how they work together:

• SBA 7(a) loan: This can serve as the primary financing source for an acquisition, which means it can be used to cover eligible purchase costs and certain working-capital needs.

• Seller financing: If the purchase price exceeds your loan amount, the seller may allow you to pay the difference over time. Typically, the note is subordinated to the SBA loan to ensure the bank is paid first in the event of financial distress.

• Working capital line of credit: If you're concerned about having available cash after you've purchased the business, a business line of credit can help cover ongoing expenses, seasonal fluctuations or unexpected costs after closing.

• Equipment loan: If the acquisition includes machinery, vehicles or other equipment, separate equipment financing can help cover those costs. Lenders will evaluate the equipment's value in determining borrower eligibility.

Gather your documents

You’ll need to submit both personal and business documents when applying for a business acquisition loan. Be ready with all required documents to help strengthen your case.

Personal documents you need include:

• Two to three years of personal tax returns: Lenders will want to see your personal tax returns for the past few years to assess your financial situation.

• Personal financial statement: Sometimes known as Form 413, this is a detailed form collecting financial information about you, any business partners and any guarantors.

• Personal credit report: Lenders will check your personal credit report and score as part of assessing your ability to repay the loan. You don’t need to pull this document yourself, but reviewing a copy can show you where you stand.

• Bank statements: Provide several months' worth of personal bank statements. This gives insight into your current financial health.

• Identification documents: Items like a driver's license or passport will be needed to confirm your identity.

Business documents you need include:

• Business tax returns: Provide three years of tax returns for the business being acquired. This gives historical data on profitability.

• Financial statements: Balance sheets, profit/loss statements and cash flow statements for the last two to three years help assess the business's financials.

• Business credit report: Like your personal credit, lenders will review the business credit report.

• Bank statements: You should include several months of business bank statements.

• Business plan: Have an updated business plan ready explaining your goals for the acquisition.

• Sales projections: This should show forecasted sales once the acquisition is complete.

• Debt service coverage ratio: This ratio is a calculation of the business's ability to service its debts. A ratio above 1.15 is ideal.

• Debt schedule: This is a list of all business debts and liabilities.

• Letter of intent: This is a signed letter detailing the proposed terms of the acquisition for the seller.

Submit your application

The loan application process is where you’ll submit all required documents, complete the application and work with the lender to assess your eligibility.

Expect the process to take anywhere from a week to several months, depending on the lender. Online lenders can fund more quickly than traditional banks.

Here are the key steps:

1. Reach out to lenders and compare options.

2. Compile all needed paperwork outlined above.

3. Fill out the full application either online or in person.

4. Submit your application and all requested documents.

5. Cooperate with the lender's requests if they need more information.

6. Wait for the lender to tell you you’re approved.

7. Sign your loan documents once the acquisition deal is finalized.

“Make sure the business is economically viable before pursuing an acquisition,” said Thomas Brock, certified financial adviser and expert financial reviewer for Annuity.org. “This is fundamental, regardless of whether you plan to finance the acquisition with debt, equity or a combination of the two.”

Brock said to carefully assess external and internal factors before you buy a business. External factors are outside of your control and can include the economy, demographic trends and laws and regulations. Internal factors relate to the business you want to buy and can include the company’s financial health, how well operations run and the potential for growth.

» FIND OUT: Is it hard to get a business loan?

How deal structure affects acquisition financing

Whether you structure the transaction as an asset purchase or stock purchase can impact what you acquire and what liabilities you assume. In turn, that can affect how lenders evaluate your eligibility for a business acquisition loan.

Here are some factors lenders are considering with each structure type:

• Asset purchase: The buyer purchases specific business assets — ranging from inventory to patents to real estate — rather than the legal entity itself. These assets can be used as collateral to secure the loan.

• Stock purchase: The buyer purchases ownership of the existing business entity, potentially inheriting its liabilities along with its assets.

Manage your loan

Once you've successfully locked in financing, the last step is to properly manage your loan and new business to ensure its success. Use these tips:

• Make loan payments on time every month. Set up autopay if possible. Even one missed payment can negatively impact your credit.
• Maintain detailed financial records. Owning a business requires financial discipline. Keep meticulous records, manage cash flow diligently and make smart reinvestment decisions. Consider hiring an accountant to take this task off your plate.
• Keep business and personal finances completely separate. Never mix your personal money with your business money. It could put your personal assets at risk if you’re sued, and it makes it more difficult to file your taxes.
• If issues arise, communicate proactively with your lender. Your lender may be able to provide some insight or leniency, depending on your situation.
• Refinance to better loan terms after one to two years, if possible. As you build a history of revenue and on-time payments, your business will be less risky to lenders. Consider refinancing if it will lower your interest rate and save you money.

FAQ

Bottom line

Acquiring an existing business allows you to purchase a proven company rather than starting from scratch. However, securing financing requires thorough preparation and an organized application.

Before you apply, check your eligibility, choose the right lender and understand how business loans work. With proper planning, it’s possible to get the funding needed to buy a business.