A Buyer's Ultimate Guide for Financing the Purchase of a Business

Pros of Seller Financing for Buyers

• Cheaper Financing: Most seller financed loans are cheaper than getting a loan from a lender.
• Access to Financing: As a buyer, seller financing can get you access to a large amount of capital that you may not qualify for otherwise.
• Quicker Closing: Seller financing can increase the speed of a deal, because there is less “red tape” involved in working out the deal.
• Fill Financing Gaps: When buyers can’t afford a 25% down payment on an SBA loan, seller financing is an excellent option to fill the gap. This also increases the likelihood that a lender will approve the loan, since a seller is willing to risk their capital on the business.

Cons of Seller Financing for Buyers

• Seller Involved Post Closing: This can be a pro or a con, but it’s something to be aware of as a buyer. If you don’t like the idea of the seller maintaining an interest in the business, then seller financing may not be the right choice for you.
• Could Lose the Business if You Don’t Pay: Sellers generally have the right to take back the business if you start to miss payments – a bank would have to sell or liquidate it, which times much more time and could diminish its value.

How to Secure Seller Financing

To secure seller financing as a buyer, you need to build trust and confidence with the seller.

Sellers who offer financing act a lot like a bank would in the business sale transaction. They have the right to check the buyer's credit, ask for a personal financial statement, resume, and other pertinent information before making a financing decision.

Since sellers should have confidence in the continued success of their own business, their decision boils down to whether they believe you will be successful in the business. Here’s what you can do to help build confidence with the seller:

Credit Score
Buyers should make sure they have a strong credit score. A good credit score is 680 or above. Above 725 is considered great. You can check your credit score online for free. Having a score lower than 680 will hurt your chances, but it won't totally eliminate you from being approved.

Down Payment
Most sellers will ask for a substantial down payment up front, because they want some kind of immediate payment for their business. Typically, you can expect to put 10-25% down.

Satisfactory Business Plan
Creating a business plan is the best way to show what your strategy for running the company will be. No matter what kind of financing you’re attempting to secure, a satisfactory business plan will increase a lender’s confidence in the future success of your business.

Personal Guarantee
The seller wants to make sure they can collect any damage you’ve done to their business if you end up not being able to make payments. Your personal assets will likely be at risk in this case. They may require you to submit a financial statement to verify your assets. Even when signing a personal guarantee, we don’t recommend pledging specific personal assets for seller financing as it ties your assets up and limits your financial opportunities.

Buying a business using an SBA 7(a) loan is no easy task. The average SBA 7(a) loan takes 60 - 100 days to complete, and there are many requirements both the business and the purchaser.

However, utilizing an SBA 7(a) loan offers many advantages for both the buyer and the seller. Here's what buyers need to know about SBA Loans:

Terms and Cost of an SBA Loan to Buy a Business

Here are the typical rates, fees, and repayment terms of an SBA 7(a) loan to buy a business:

• Loan Amounts: Up to $5 million
• Interest Rates: SBA loan rates vary based on the current U.S. prime rate, which is typically around 6-9%.
• Fees: SBA loan fees start at 3% of the loan amount for loans over $150K. There may be additional fees as well, including application fees, third-party closing fees, or prepayment fees.
• Repayment Schedule: The standard term for a SBA 7(a) loan is 10 years for working capital and 25 years for real estate.

Qualifying for an SBA 7(a) loan

To qualify for an SBA loan, you typically need to meet following criteria:

1. Credit Score: Buyers will want to have a credit score of 680 or above
2. Down Payment: Generally, 10-30% of the loan amount
3. Sufficient Collateral: Business and/or personal assets. Real estate is preferred
4. Industry Experience: More than 3-5 years is preferred, but you could also have someone with industry experience run the business instead of you
5. Buying a Financially Strong Business: The business your purchasing must be finically viable enough to repay the loan

If you can put a check next to each of the criteria above, your chances of qualifying for a loan are good. If you’re not that strong on one or two of these criteria, that doesn’t mean that you can’t get a loan, but it will be much more difficult. If that’s the case, be prepared to talk through those weaknesses in your application with your loan provider.

Other SBA 7(a) Eligibility Requirements

In addition to the requirements listed above, the SBA has other eligibility requirements, including:

• The business must be a small business as defined by the SBA
  • Under 500 employees,
  • Average annual revenue under $7.5 million (for past 3 years)
  • Average net income under $5 million (after federal income taxes, excluding carry-over losses)
  • Tangible net worth under $15 million
  • Be a for-profit business with a location in the U.S. and operate primarily within the U.S.
• Buyer must use alternative financial resources, including personal assets, before seeking financial assistance
• Buyer must be able to demonstrate a need for the loan proceeds
• No defaults or bankruptcies on prior SBA loans
• Not delinquent on any existing debt obligations to the U.S. government (including taxes and student loans)

Securing a Down payment

Many buyers struggle to secure the full down payment needed to purchase a business, but there are other methods of meeting this requirement.

Seller Financing
While not technically considered part of your down payment, seller financing is a great way to meet your down payment requirements.

Rollover for Business Startup (ROBS)
Rollover for Business Startup, or ROBS lets you roll over money you’ve saved in a retirement account without paying taxes or withdrawal penalties. We advise using a ROBS only if you have at least $50,000 in your retirement account that you plan to use. In addition, it’s best to use a professional ROBS provider to assist you with this process as the tax and legal issues involved are very particular.

Cash Out 401k or IRA
You may also cash out your IRA or 401k account, but due to the heavy taxes and penalties we don't reccomend it. Even if you’re in the lowest tax bracket, you’ll have to pay state & federal income taxes, in addition to a 10% early withdrawal penalty.

Home Equity Loans and Home Equity Lines of Credit
Homeowners can use a home equity loan (HEL) or a home equity line of credit (HELOC) to contribute towards a down payment. However, this option will reduce the amount of equity available in the property to be used as collateral for your business loan.

SBA Loan Application and Additional Documents

Before you apply for a SBA 7(a) loan, you will be asked to submit certain documents for the business. Some lenders will require you to send additional documents, but according to their standard operating procedure, here are the main documents you’ll need.

Purchase Agreement

The purchase agreement is the document that states:

• Final purchase price of the business
• Deal structure (stock vs. asset sale)
• What is required by both the seller and buyer at closing
• Effective date that ownership of the business is transferred
• If and how the seller will help with transition
• Statements identifying the responsibility for existing liabilities

The lender needs the purchase agreement to verify the business’ purchase price and learn more details about the business and whether some of what is being purchased may be considered collateral.

Financial Documents for the Business

• Last 3 years business tax returns
• Year to date (YTD) profit and loss, balance sheets, and cash flow statements
• Information on outstanding business debts
• Information on any long-term contracts
• Complete list of business assets (including year, make, model, mileage/hours)
• Rent rolls if the business has tenants
• Business lease
• Organizational documents for the business (e.g. incorporation docs and business licenses)
• Business Plan

Rollover for Business Startups, also known as ROBS, is one of the most popular ways of coming up with a down payment for a business.

ROBS allows you to use the money saved in a 401k or IRA as down payment without paying early withdrawal penalties, or taxes.

ROBS is not a business loan or a 401k loan, so there's no paying back debt or interest. It is simply a rollover that invests in your new business, in the same way you would invest in mutual funds.

A study by Guidant Financial found that 81% of small businesses funded with a ROBS were still operating after 4 years, compared to only 39% of traditionally funded business.

How to Create a ROBS

Setting up a ROBS typically requires the help of experienced CPAs and attorneys, so we recommend finding a professional who specializes in this type of financing. Nevertheless, here is a general overview of how a ROBS is formed: 

1. Form a C Corporation
In short, a C Corporation is the only corporate entity that has the ability to qualify for a ROBS. Sole Proprietorships, LLCs, LLPs, or S Corporations do not qualify.

2. Create a 401k Plan for the C Corporation
Next, you must establish a retirement plan for your C Corporation. This includes deciding on what type of retirement plan to offer, and finding a custodian that can manage the actual investments of the retirement plan (Wells Fargo, Merrill Lynch, or Schwab). Here are your plan options:

• 401(k) Plan (most popular)
• Defined Benefits Plan
• Defined Contribution Plan
• Profit Sharing Plan
• A combination of plans, like a 401(k) with a profit sharing component 

3. Transfer funds from personal retirement account to C Corporation retirement plan
Once your C Corporation retirement plan is set up, transfer funds from your personal account into the C Corporation retirement plan.  Once the company retirement plan is set up within your new C corporation, your personal retirement funds are transferred to the new retirement plan.Retirement Plan Purchases Stock in the Corporation

Now, the funds in your new retirement plan can be used to purchase stock in your C Corporation. Since a ROBS can be used in conjunction with other financing, like SBA loans, personal savings, or outside investors, you will match the number of shares to the percentage of startup financing you need to meet your obligations. 


4. Funds become available to Corporation
Once you’ve completed the four steps above, the proceeds from your ROBS will be available for use. Keep in mind that your ROBS requires ongoing administrative and operational duties. This is why we reccomend using an experienced and reputable ROBS provider.

What does Operating a ROBS Cost?

Most ROBS providers will charge you two fees:

1. Upfront Setup Fee

Providers will charge up to $5,000 to set up your ROBS (prices may vary). The funds from your ROBS cannot be used to pay this fee.

2. Ongoing Monitoring Fee

Depending on the provider, your fee can range anywhere from $120 to $150 per month, plus an employee fee if you have more than 10 eligible employees.