Business buyer financing is one of the most important decisions you’ll need to make in securing a solid buyer. There are different sources of financing available for existing businesses, each with its advantages and disadvantages.
In this article, we will review five common financing options for business buyers: traditional commercial banking, private equity, family offices, commercial mortgages, and venture capitalists. And we’ll review what is the best way for you to apply for a loan in the journey to completing a business purchase,
Traditional Commercial Banking
Traditional commercial banking refers to obtaining a loan from a commercial bank, usually one that operates on the high street. This buying a business finance option is often the preference of buyers with a strong credit history, a stable income, and a low debt-to-equity ratio. The main benefits of traditional commercial banking are:
- Lower interest rates than other sources of financing;
- Longer repayment terms than other sources of financing;
- Ability to negotiate the loan terms and conditions;
- Possibility of obtaining additional services from the bank, such as cash management, insurance, or advisory.
The main drawbacks of traditional commercial banking are:
- Higher collateral requirements than other sources of financing;
- More stringent due diligence and documentation processes than other sources of financing;
- Higher risk of default and foreclosure if the business performance declines;
- Less flexibility and control over the business decisions than other sources of financing.
Private Equity
Private equity refers to obtaining equity financing from a private equity firm, which is an investment company that specializes in buying and selling businesses. Buyers that turn to this option often have a high growth potential, a strong management team, and a clear exit strategy.
The main benefits of private equity are:
- Access to large amounts of capital than other sources of financing;
- Access to the expertise and network of the private equity firm;
- Ability to leverage the private equity firm’s reputation and credibility;
- Possibility of obtaining additional support from the private equity firm, such as strategic guidance, operational improvement, or governance.
The main drawbacks of private equity are:
- Higher cost of capital than other sources of financing;
- Shorter repayment terms than other sources of financing;
- Loss of ownership and control over the business decisions than other sources of financing;
- Higher pressure and expectations from the private equity firm.
Family Offices
Family offices refer to obtaining equity financing from a family office, which is a private wealth management firm that serves one or more affluent families. This option is often the right one for buyers with a long-term vision, a strong alignment of values, and a desire for social impact. The main benefits of business acquisition loans via family offices are:
- Lower cost of capital than other sources of financing;
- Longer repayment terms than other sources of financing;
- Ability to build a trusting and lasting relationship with the family office;
- Possibility of obtaining additional benefits from the family office, such as philanthropic opportunities, mentoring, or referrals
The main drawbacks of the family office type of finance are these:
- Limited availability and accessibility of family offices than other sources of financing;
- More selective and subjective criteria for investment than other sources of financing;
- Less transparency and accountability than other sources of financing;
- Potential conflicts of interest or interference from the family office.
Venture Capitalists
In short, venture capitalists refer to obtaining equity financing from an investor who provides capital to start-ups or early-stage types of businesses. Buyers that favour this option often have an innovative product or service, a large market opportunity, and a scalable business model. The main benefits of venture capitalists are:
- Access to high-risk, high-reward capital than other sources of financing;
- Access to the knowledge and connections of the venture capitalist;
- Ability to attract more investors and a higher customer base with the venture capitalist’s endorsement;
- Possibility of obtaining additional resources from the venture capitalist, such as mentoring, coaching, or feedback.
The main drawbacks of venture capitalists are:
- Higher dilution and loss of ownership than other sources of financing;
- Shorter repayment terms than other sources of financing;
- Loss of autonomy and control over the business decisions over other sources of financing;
- Higher competition and scrutiny from the venture capitalist.
Commercial Mortgages
There are other seller financing options buyers of small businesses may have in their business plan. For instance, another financing option you may encounter is commercial mortgages. These are bank loans to buy secured commercial properties, such as offices, shops, or warehouses. They can be a financing option for those looking to buy an existing business or borrow money simply to expand their existing one.
Financing options to avoid when buying established businesses
Some financing options may have higher interest rates than others, which can affect the profitability and cash flow of the business.
Generally, the finance options that have the highest interest rates are those that involve more risk for the lender, such as unsecured loans, credit cards, or merchant cash advances. These types of financing do not require any collateral or personal guarantee from the borrower, but they charge higher fees and interest rates to compensate for the potential loss. They may also have shorter repayment terms and stricter eligibility criteria.
On the other hand, the finance options that have lower interest rates are those that involve less risk for the lender, such as secured loans, equity financing, or seller financing. These types of financing require some form of collateral or ownership stake from the borrower, which reduces the lender’s exposure to default. They may also have longer repayment terms and more flexible eligibility criteria.
Summary of Business Buyer Financing
In conclusion, there are different financing options for business buyers, each with its pros and cons. The choice depends on various factors, such as the buyer’s profile, the business’s characteristics, and the market conditions.
Therefore, buyers should conduct a thorough analysis and comparison of the available options before making a decision.