Very few purchases of small businesses are done on all cash basis. While most business owners would like to sell for cash, demanding it suggests to the buyer that something may be wrong with the business or that the seller is desperate.

Seller Financing

Almost all purchases of small businesses are structured so that a substantial portion of the purchase price is funded by the seller, alone or in conjunction with an infusion of cash from a commercial lender. The deal is structured to provide a reasonable down payment, with the balance financed by the seller at a fair interest rate, and allowing a reasonable period of time to repay the note, usually five to seven years. The business itself serves as collateral for the loan.

Over eighty percent of all small businesses sold in recent years have been sold with one third down and the owner financing the balance. By financing the deal in this manner, most sellers are able to realize a selling price substantially more than in an all cash transaction and, furthermore, are able to postpone some capital gains taxes.

Seller financing is generally hassle-free. The business doesn't have to pass the rigors of a lending institution, nor does the buyer individually.

Seller financing is a winner for both buyer and seller. The seller will have too much at risk to misrepresent the business. A buyer will have too much invested to let the business fail. And the buyer is assured that the seller has enough confidence in the viability of the business to know that it will pay for itself over the life of the note. Consequently, the buyer and seller become a team – their futures are each dependent on the success of the business.

SBA Loans

Loans guaranteed by the U. S. Small Business Administration are also a popular source of funding for buyers. A buyer may use such funds to augment the down payment and/or reduce the amount of seller financing. They are offered by large, non-bank lenders, such as CIT, as well as many commercial banks. The non-bank companies are often favored by buyers because of their specialized knowledge, service and experience. Most important, while SBA lenders derive collateral from the company’s tangible assets, they will also loan against a company’s cash flow or goodwill. Thus, it may be the only institutional lending source for transactions where tangible asset value is not substantial, such as in many service businesses.

The drawbacks to SBA loans are that because of government requirements they involve substantial paper work by the lender and attorneys, can be time consuming and expensive, and often require personal collateral from the buyer, such as home equity.

Commercial Banks

Banks, while they purport to seek business acquisition loans, are not major participants in small business transactions. By their nature, they specialize in loans that require tangible assets as collateral, such as real estate, equipment, inventory and accounts receivable. They will also lend against a buyer’s personal assets, such as his home equity or stock portfolio. Where such assets are available as collateral in sufficient quantity, commercial bank loans can sometimes augment seller financing.

As with SBA loans, the bank loan application and approval process can be time consuming. Banks tend to be highly structured and often require loan reviews at several organizational levels by loan officers and committees. Plus, after a loan has been completed, their need for information about the continuing performance of the business, to assure compliance with loan requirements, can be somewhat onerous.

Non-Bank Lenders

Non-bank lenders, such as a mezzanine fund or Small Business Investment Company (SBIC), sometimes participate in larger transactions. They are often aggressive and flexible in their stated willingness to do a loan, but their interest rates can be high and they can pose significant demands on the borrower.