You’re ready to buy a small restaurant business and on the way to negotiating a purchase agreement. But hold on a minute. How knowledgeable are you about the various financing options for small business sales? Each approach brings a unique set of conditions to the sale. It’s also important to note that while some financing options benefit buyers, others benefit sellers and could place you at a disadvantage in the buying process.
This isn’t to say that you have to become a business financing expert if you want to buy a restaurant. That’s one of the reasons you’re working with a broker and/or other trusted professional advisors. However, an understanding of the basics will help clarify your options and equip you with the information you need to make the right purchase decision.
Here are six financing options to consider when buying your small restaurant business:
1. Seller financing. Seller financing provides buyers with several benefits. Most important, it gives the buyer a degree of security and confidence, as the seller has a continued incentive in having the business perform well. Borrowing from the seller also creates more negotiating opportunities for the buyer than they would ordinarily have with a traditional lender, such as a bank. Buyers might be able to stretch out their payments over longer periods to keep payments smaller or they could even offer the seller equity in the business, or earn-outs based on profitability. Sellers can also benefit by deferring sale proceeds across multiple years to potentially lower taxes associated with the sale.? Seller financing has become an increasingly important part of the deal structure in recent years as traditional lenders have tightened their lending standards. Luckily, sellers are taking note of this and are including seller financing in more of their deals.
2. Borrowing from a 401(k). This option allows buyers to tap into their 401(k) plans or IRAs. When using it, buyers roll their retirement funds into stock for a new business without incurring any tax or early withdrawal penalties. Typically, 401(k) funds are only used to pay for part of a business acquisition, not the entire purchase price. The benefit of this approach is that the buyer’s 401(k) leverages their own money. Unlike traditional forms of financing, there are also no prequalification concerns. The downside, however, is that the money was supposed to be used to pay for their retirement. If the business doesn’t provide the expected return, it’s likely that the buyer will have to sell the business to recoup some retirement capital.
3. SBA-backed and third party loans. Though the availability of bank loans to finance business purchases is improving, many banks remain leery of funding business purchases, especially if the buyer is unproven as an entrepreneur and/or in the industry of interest. So when commercial financing is difficult for prospective business owners to secure, buyers often rely on third-party loans and SBA-backed loans to fund the down payment or some other portion of the sale.
The Small Business Administration (SBA) offers two loan programs that can help entrepreneurs get the capital they need to purchase their business: the 7(a) guarantee small business loan and the 504 fixed-asset small business finance program. The 7(a) guarantee loans are more common for small businesses due to their versatility. Companies can use 7(a) guarantee loans for many business purposes, including real estate or equipment purchases, expansion, working capital or inventory. The money can be paid back over as many as 25 years for real estate and 10 years for working capital. Interest rates are a maximum of 2.75 percent if over seven years. ?On the other hand, the SBA’s 504 fixed-asset small business finance program provides long-term, fixed-rate financing for businesses acquiring new facilities or purchasing equipment to update existing locations. The 504 program focuses on helping a small business purchase the assets needed to take it to the next level. Loans cannot be used for working capital or purchasing inventory, which are allowed uses under the SBA’s primary 7(a) program.
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4. Family and friends. Asking family and friends for loans is one of the most common ways to finance a small business purchase. Despite this, many people remain hesitant to borrow money from friends and family for fear of straining personal relationships. By making it a point to stay true to the deal under all circumstances and borrow only from individuals who are in a position to lend, this can serve as one of the most effective ways to fund a business. Also, make sure to have a well-thought-out game plan before approaching family members or friends. Regretfully, business success is not a sure thing, but by professionally approaching family and friends, and communicating frequently on the progress of the business, the chances of maintaining good relationships are significantly higher.
5. Personal savings. It's no secret that the most popular and preferred source of financing a small business purchase is personal savings. By using their own funds, buyers are able to avoid paying high interest rates, as well as eliminate wasted time that would otherwise be spent trying to navigate the various other lending options. However, before dumping your entire life savings into your business purchase, think realistically about what percentage of your personal savings you should use.
6. Peer-to-peer financing networks. Peer-to-peer (P2P) financing networks are online investment platforms that typically attract buyers who can’t obtain traditional financing because of their credit status or lack thereof. Since P2P networks operate with low overhead, they can sometimes offer lower interest rates than traditional lenders. If you want to use this route for a loan, you can do so via online companies such as Prosper.com and LendingClub.com. On these sites, loan seekers request a specific amount (typically up to $25,000) at a specific interest rate, and lenders fund all or portions of the loan. Lenders are then paid back with interest over a set period of time.? P2P networks are just starting to gain steam with small business buyers, so be sure to do your research before setting your sights on going this route.