Accessing finance to buy an online business can be a tricky area. It is essential to evaluate all potential sources of funding including seller financing. While some investors do have cash readily at hand and are just looking for an investment with profitable returns, most buyers certainly have the energy, enthusiasm and ideas to invest but fall well short of having the total funds required. Hence the need for borrowing.
Most mainstream lenders, particularly banks, are reluctant to lend for online businesses. If you are intending to build your own business from scratch, you can basically forget about a bank loan. If you are buying an established online business your chances are only slightly higher. Even where there is audited evidence of financial success over a period of at least two to three years, typically online businesses have very little in the way of saleable physical assets or inventory to provide collateral. Even if the borrower has separate assets such as real estate to mortgage, major banks tend to shy away from lending for online business purchases even if the loan is fully secured. Banks aren’t sentimental, but foreclosing on mortgages is never a good look for them!
So, where to go for a loan?
Perhaps surprisingly the most common loan source for startups and online business purchases still remains family and friends funding. In most cases this comes with some advantages but many drawbacks and limitations. Alternatively there are numerous small business lending providers who are willing to back an online business purchase, but usually at a hefty interest rate and with a relatively limited pay-back period required as part of the contract. Obviously unsecured loans are more expensive than secured loans. While this is always a borrowing option, think carefully before committing to one of these loans as paying it off could be financially draining.
What about an SBA loan?
Depending on your circumstances this could be where an SBA loan comes in. The US Government Small Business Administration loans underwriting program is designed to enable funding of small businesses as an incentive for investment and as an economy growing measure. The SBA program has numerous strands and is designed to meet many different contingencies, including even business loans for disaster recovery. However, in the case of borrowing to purchase an existing online business the relevant scheme is the SBA 7(a) loan.
How does an SBA loan work?
The government does not lend any of the money directly to the borrower. Rather it guarantees the loan, or typically a high proportion of it such as 85%, for the security of the lending institution. Many but not all banks will consider loan applications where the borrower is securing an SBA guarantee. The process is complex and quite arduous for the borrower, so it is vitally important to source in advance a bank or other major lending institution which has plenty of experience with loans underwritten by the SBA and the capacity to provide advice and guidance throughout the application stages.
Because the process is time-consuming, working with a potential lender without an established record in fast-tracking SBA loans will definitely delay the process to an extent which may dissuade the seller from entering into an agreement. Even with an experienced SBA lender the loans process is still likely to take somewhere between 45-90 days. This is very important to understand because a formal letter of intent to purchase and signed Agreement subject to SBA-guaranteed finance must be lodged before the application will be considered.
There are many private SBA loan facilitation specialists who will guide you through the process and connect you with a lender most likely to approve your SBA-guaranteed loan application – but for a fee of course. This cost can significantly erode your net financial position before you even start, so it’s worth investing the time and effort to understand the process so you can work your own way through it.
These are pretty strict, which is why only a small (but growing) proportion of borrowing for online business purchases comes from this source.
Technically the borrower does not have to be a US citizen but the business development needs to be considered economically beneficial within the US and any borrower who is a foreign national needs to meet strictly defined residency status conditions.
The qualification requirements are too complex to cover in full here, but in a nutshell the business itself must be:
- based primarily in the US
- within the technical definition of a ‘small business’
- for profit – and demonstrably profitable
- an existing business, established for at least 2 years, with invested equity.
Any person borrowing for investment in the business must have:
- an established credit score (at least in the high 600 range)
- a bankruptcy-free record
- no criminal history
- no unpaid debts to any Federal agency
- demonstrated competence to manage and develop the business proposed for purchase
- an absolute minimum of 10% deposit after all fees incurred in the acquisition have been accounted for.
Detailed business financials and a clear business plan need to be provided with the application and it must be demonstrated that there is a proven need for an SBA loan. That is to say, other sources of finance are not available or financially viable for the borrower.
Advantages for buyers
Don’t let the seeming complexity of all this put you off. After all, your business success relies on diligence and perseverance! The advantages of an SBA-guaranteed loan are enormous, including minimum personal equity required, favourable interest rates and an extended loan repayment period.
It also provides you with substantial reassurance of the business profitability and development viability if the seller is willing to undertake the degree of financial and business plan scrutiny which the SBA loan process requires.
Implications for sellers
If you are confident of the worth of your business and want to secure the highest possible sale price, and if an ultra-short settlement period isn’t your highest priority, then entering into an agreement with a buyer intending to use an SBA loan may be a win-win outcome. Those buyers with ready cash or access to a rapid funding source will expect a discounted price in return for the certainty of a quick settlement. Cutting out a prospective buyer who is depending on an SBA loan will narrow your field of potential purchasers and may not yield the high sale price you could achieve.
The SBA-guaranteed loans program is a significant source of buyer finance for small businesses. The online business segment is still only a small proportion of these loans. But to provide just a slight indication of the scale here, Wells Fargo’s annual lending in the SBA 7(a) loans field alone is worth around $5 billion. Five billion dollars from just one single SBA lender. That’s a lot of small business investment money to spread around.
So, as online business sales increase, as a seller it’s certainly a good idea to be open to an SBA funded purchase offer.