Pros and cons of business acquisition loans

If you’ve decided to take the plunge and buy a business, you’ll need to look into how you can fund the business acquisition. You can raise funding for the business through investors, crowdfunding campaigns or venture capital firms — or you can choose debt financing through a business acquisition loan.

Business acquisition loans allow you to buy the business without needing all the funds upfront, selling equity or giving commissions to the previous owner. But you may find yourself needing to fill out extra paperwork and having to find the right lender to fund your acquisition. Before signing a business acquisition loan agreement, it’s important to weigh the pros and cons.

What is a business acquisition loan?

A business acquisition loan is any small business loan used to acquire a small business or fund a franchise. The loan is used to buy the business, including its intellectual property and inventory, and pay other expenses such as employee payroll. The best business acquisition loans will offer favorable repayment terms and interest rates and fund the entire business acquisition.

The business may or may not be turning a profit at the time of acquisition. In either case, the lender may want to see a business plan to understand how you will make or grow the business profits.

Compare the pros and cons of business acquisition loans

Pros

• Lowers the capital needed to buy a business
• Potentially fast turnaround times
• Flexible collateral requirements
• Long-term financing to reduce costs

Cons

• Difficult to qualify for
• May require a down payment
• Potentially high interest rates
• May require extra documentation

Pros of business acquisition loans

Getting a small business acquisition loan comes with several benefits:

Lowers the capital needed to buy a business

The main attraction for getting a business acquisition loan is the ability to buy a business without needing all the capital upfront. Instead, you can use the business profits to make the loan payments. You also get the benefit of keeping much of the capital you do have, which you can use to reinvest into the business or to build business emergency savings.

Potentially quick turnaround times

The approval timeline depends on the lender you choose, but many online lenders can approve your business loan quickly, such as 48 hours or less. You have a better chance of getting approved quickly if you have all your documentation lined up and solid business finances to prove that you can repay the loan.

Flexible collateral requirements

You may be able to offer business assets to secure the loan, such as equipment, real estate and, in some cases, intellectual property. Offering collateral can help you get approved for an acquisition loan for a business and qualify you for lower interest rates.

But not all business acquisition loans require collateral. You may have the flexibility to choose an unsecured loan over a secured loan, protecting your business assets from getting seized if you can’t make payments.

Long-term financing to reduce costs

When financing a business acquisition loan, you may choose to finance with a long repayment term. Long-term business loans offer terms of three to 10 years or more, helping to lower monthly payments and successfully manage the business loan. Many acquisition loans have large loan amounts, so it can help to spread the amount over the long term.

Cons of business acquisition loans

While an acquisition loan can help you buy a business without needing all the capital on hand, there are downsides to this type of loan. Those include:

Difficult to qualify for

Most business loans want to see a solid credit history and ample revenue, showing that you have the ability to repay the loan. You’ll need to meet the lender’s criteria to qualify for the loan. Those criteria often include having a personal credit history of 600 to 670, at least a year or more in business and annual revenue between $100,000 to $250,000.

Because you won’t currently be running the business until after the acquisition, you’ll need to find a lender willing to accept funding for an acquisition. It will also need to accept the business’s current financial standing. If the business isn’t turning a profit, you may have to seek out a startup business loan, which caters to businesses in the beginning stages of growth.

May require a down payment

Most business loans require enough capital for a down payment on the loan, often 10 percent to 20 percent of the loan amount. Having a sizable down payment can help you get approved for the loan.

Because of the high loan amounts for acquisition loans, it’s not likely that you’ll get a business loan without a down payment. You should expect to need some capital on hand, but you may find a lender that approves business loans with no money down, particularly if you have collateral.

Potentially high interest rates

Some business acquisitions are essentially startups without much of a proven financial track record. Because of this, expect higher interest rates than if you were getting a business loan for a different purpose. Average business loan interest rates run anywhere from 6 percent to 45 percent, with the higher rates given to businesses that are considered higher risk to lenders.

But you might avoid the high interest rates if the business has been operating for several years and is already profitable.

May require extra documentation

Business acquisition loans will require much of the same documentation as other business loans. Those include business financial statements and tax returns, a balance sheet showing assets and liabilities and the prospective owner’s personal credit history.

But because of the acquisition, the lender may also need to see a statement showing the terms of the acquisition, business formation documents and a business plan. Because acquisitions can be complex, you may need legal assistance for drafting the acquisition terms.

Types of business acquisition loans

You can use nearly any type of loan for a small business acquisition loan. Term loans may be the most common type of loan, providing flexible options for long repayment terms and high loan amounts, but there are several types of business loans that can be used for acquisitions:

Business acquisition loan requirements

To get a business acquisition loan, you’ll need to understand the business’s value and show the details of the sale. You’ll also need to meet your chosen lender’s requirements, including documentation and annual revenue. Here are the steps to getting a business acquisition loan:

1. 1. Get a signed letter of intent. The signed letter of intent is the statement that shows the terms of the acquisition between both parties. The lender will want to see the terms of the agreement to understand how the acquisition will proceed and its costs.
   2. Compare lenders that will fund the business acquisition amount. You will want to compare lenders that can fund the full amount you need to buy the business. For example, some lenders stop loan amounts at $500,000, while your business acquisition may cost you more. You’ll also want to compare requirements, such as annual revenue and time in business, repayment terms and interest rates. Be sure to calculate the monthly business loan payments to make sure that you can handle the loan.
   3. Gather business loan documentation. To apply for the business acquisition loan, you may need this list of documentation on hand:
      • Signed letter of intent
      • Business bank statements
      • Business tax returns
      • Balance sheet
      • Business market valuation
      • Appraisals of business assets like equipment
      • Personal credit history and bank statements
      • Business plan
   4. Apply for business acquisition loans. You can apply for a variety of small business loans, comparing the loan offers to choose the most favorable option. Some lenders will allow you to prequalify to see what you qualify for without having a hard check on your credit.

   Bottom line

   A business acquisition loan is useful for helping you get the capital needed to buy a business or franchise. You can also search for lenders that will offer high loan amounts, long repayment terms and flexible collateral requirements.

   But since acquisition loans are often used for startup businesses, you may need an ample down payment and a solid financial track record to get approved for the loan. Lenders ultimately want to understand the terms of the acquisition and be reassured that the borrower can repay the loan from business revenue.

   Frequently asked questions

   • How does a business acquisition loan work?

     A business acquisition loan works by approving a buyer for funding to purchase another business. To get approved for a business acquisition loan, the lender will usually want to see the letter of intent detailing the terms and costs of the acquisition. It will also want to see ample financial documentation to prove that the business can repay the loan. Once approved, the buyer will use the loan funds to buy the business and then begin repaying the loan, ideally with the business’s revenue.

   • What is the interest rate for acquisition financing?

     Business acquisition loans can come with rates running from 6 percent to 45 percent or more if you have subprime credit or a lack of credit history. Expect the interest rates to stay on the higher end unless the business has strong finances.

   • Can I get a business acquisition loan with bad credit?

     It’s possible to get a business acquisition loan with bad credit, such as a personal credit score in the 500s to 600s. But you may be limited in the types of loans or the lenders you qualify for. You may have to look into bad credit business loan options to find one that will approve you. These can include specific bad credit lenders or alternative loans, such as invoice financing or merchant cash advances. You may also be limited in how much the lender will approve you for financing.