If you are interested in purchasing your own business and becoming your own boss but aren't sure if you have the finances to do so, you are not alone. A lot of people aren't aware that there are multiple ways to finance the purchase of a business. The most common ways we see people finance the purchase of a business are Cash, Bank Financing, Seller Financing, and Investors.
- You can take money from your savings account to finance the purchase
- Investment Account
- Withdraw from your 401(k). You can withdraw money from your 401(k), but you will want to take into account that there will be a penalty for withdrawing early. You will have to pay taxes on the income you are gaining from the previous pre-tax contributions made into the account.
- Self-directed 401(k). You can use your 401(k) to invest in your own business. With this method, you will want to start a C-Corporation and will use your 401(k) to purchase stock in your business. The major benefit of this will be avoiding the taxes you would normally have to pay if you were just withdrawing from your 401(k). We typically see people utilizing this method when the amount of cash they are using is $50k or above. If you are interested in using this method of financing or would like some additional information we encourage you to reach out one of our financing partners, Directed Equity or Benetrends.
- Home Equity Line of Credit (HELOC). You can use a HELOC to purchase a business. You will typically want to have 80% equity in your home before you start looking at this method of financing.
- Conventional Loan. A typical loan you would get from a bank. This method of financing for purchasing a business is fairly rare today.
- SBA Loan. This is a bank loan that is typically about 80% guaranteed by the Small Business Association. Each bank will have their own standards and requirements for this type of loan. In regards to the business you are seeking to purchase, the bank will look at the business performance to see if it will enable you to pay back the loan without significantly affecting the cash flow of the business. In regards to the borrower, the bank will typically look at credit score, industry experience, outside income, and what type of collateral you might be using. Also, banks usually like to see a borrower putting 20-30% down on the total purchase price of the business. Every bank operates differently when deciding whether to make a loan.
- Seller Loans to Buyer. This type of financing is similar to a bank loan, however, there is much less regulation. In our experience, the seller often requires a 50% down payment. However, the down payment is always negotiable. Also, these types of loans will often have a slightly higher interest rate than you would see with a bank loan, usually around 5% to 8%. The term of the loan usually depends on the size of the loan. Smaller loans can be as short as a year, and larger loans could be for a 5-year term. Again, you will want to take into account the monthly payments on the loan to make sure it does not significantly affect the cash flow of the business.
- Investors/Friends/Family. This would require a private agreement between each of the parties involved. It is important to set this agreement up before you and/or your investors begin the process of finding a business to purchase.
If you are interested in buying a business or simply would like more information about financing options please join us for a consultation.
Matt Prescott, Business Broker with Transworld Business Advisors of Denver
***Transworld is not a banker and we do not provide financial advice. The methods listed in this blog post are typical methods that we see in the industry. To gain more information we recommend you speak to a banker or financial professional of your choosing***