How to Get a Loan to Buy a Business
Not everyone wants to take on the challenge of building a business from the ground up. An attractive alternative can be to step into a business that’s already up and running by purchasing it from the current owner. Some advantages of buying a business may include easier financing, an established customer base and an existing cash flow.
Buying a business is different from buying a franchise. Franchises have a set business model that’s proven to work. However, when you buy an independently operated business, it’s important to show the lender that you, your previous business experience and the business you want to buy are a winning combination.
What lenders look at when you want to buy a business
Because lenders can view the performance record of an existing business, it’s typically easier to get a loan to purchase an existing business compared with startup funding. However, your personal credit history, experience and details about the acquisition business still matter.
Your personal credit and experience
Through credit reports and credit scores, lenders are able to assess how you’ve managed debt in the past and potentially gain insights into how you will handle it in the future. Your education and experience will also be evaluated.
Solid credit history: Lenders look to see if you have a history of paying your debts. Foreclosures, bankruptcies, repossessions, charge-offs and other situations where you haven’t paid off the full amount will be noted.
Business experience: Having worked in the same industry as the business you want to purchase is helpful. Related education can also be viewed as a positive.
Other businesses you’ve owned
Having a track record of operating other successful businesses can have a positive influence on lenders when it comes to buying a new operation.
Record of generating revenue: Business financial statements can help a lender document that your current or past businesses were well-managed and turned a profit.
Positive credit record: Lenders review business credit scores and reports to verify creditworthiness and to identify liens, foreclosures, bankruptcies and late payments associated with your other businesses.
The business you want to buy
Just because a business is operating doesn’t mean it’s a good investment. Lenders will ask for documentation, often provided by the current owner, to assess the health of the operation.
Value of the business: Like you, your lender will want to ensure that you’re buying a business that has value and that you’re paying a fair price.
Past-due debts: Lenders will be interested in the business’s past-due debts, which may include liens, various types of taxes, utility bills and collection accounts.
Most lenders will let you know what they want included in the loan application package, but there are some personal documents that are typically requested, as well as ones related to the business you want to purchase.
The following documents are used to evaluate your personal finances, business history and plans for operating the business after its purchase:
Personal tax returns.
Personal bank statements.
Financial statements for any of your other businesses.
Letter of intent.
Documents from the current business owner will also be evaluated. Some common ones requested by lenders include:
Business tax returns.
Profit and loss, or P&L, statements.
Business balance sheet.
Proposed bill of sale.
Asking price for inventory, machinery, equipment, furniture and other items included in the sale.
Where to get a loan to buy a business
Compared with finding a loan to start a business, getting funding to buy an existing business may be easier. Here are three popular funding options to check into for a business loan:
Banks generally offer the lowest interest rates and best terms for business loans. To qualify for this type of loan, you’ll typically need a strong credit history, plus the existing business will need to be in operation for a certain minimum of years and generate a minimum annual revenue amount set by the lender.
If borrowers don’t qualify for a traditional bank loan, then SBA loans, ones partially guaranteed by the Small Business Administration, may be the next option to explore. Because there is less risk to the lender, these loans can be easier to qualify for. Banks and credit unions frequently offer SBA loans in addition to traditional bank loans.
Online business loans
Another option to consider is online business loans. Online business loans may offer more flexibility when it comes to qualification, compared with bank and SBA loans. Minimum credit score requirements can be as low as 600, and in a few cases lower. Generally, interest rates are higher than what’s available with a traditional bank loan.
Overdraft Protection: What It Is and Different Types
Overdraft fees can be a major drain on your finances. Some banks charge more than $30 per overdraft and potentially charge that fee multiple times per day if you keep making transactions that overdraw your checking account. If you want to avoid these fees, you can typically opt out of overdraft coverage with your bank. It can be useful, however, to set up overdraft protection instead of opting out so you don’t find yourself unable to pay for something urgent.
What is overdraft protection?
Overdraft protection is a checking account feature that some banks offer as a way to avoid overdraft fees. There are several types of overdraft protection, including overdraft protection transfers, overdraft lines of credit and grace periods to bring your account out of a negative balance. Some other overdraft coverage programs might be a combination of these features.
Before you opt out of overdraft protection altogether — which means your bank will decline any transaction that would result in an overdraft — consider how you might need overdraft coverage in an emergency. For example, maybe you’re using your debit card to pay for gas on a road trip. You need enough fuel to get home but don’t have enough money in your checking account. Instead of dealing with running out of gas, you may want to deal with an overdraft.
How does overdraft protection work?
Here are more details about the main types of overdraft protection that banks tend to provide.
Overdraft protection transfers. When a bank allows you to make an overdraft protection transfer, you can link a savings account, money market account or a second checking account at the same bank to your main checking account. If you overdraft your checking, your bank will take the overdrawn funds from your linked account to cover the cost of the transaction. Many banks allow this service for free, but some banks charge a fee.
Overdraft lines of credit. An overdraft line of credit functions like a credit card — but without the card. If you don’t have enough money in your account to cover a transaction, your bank will tap your overdraft line of credit to cover the remainder of the transaction. Lines of credit often come with steep annual interest rates that are broken up into smaller interest charges that you keep paying until the overdraft is paid back. Be aware that a line of credit could end up being expensive if you use this option to cover your overdrafts.
Grace periods. Some banks offer grace periods, so instead of immediately charging an overdraft fee, the bank will give you some time — typically a day or two — to return to a positive account balance after overdrafting. If you don’t do so within that time frame, your bank will charge you fees on any transactions that overdrafted your account.
Other coverage programs. Some banks are taking a new approach to overdraft protection by offering what’s basically a free line of credit with a longer grace period for customers to bring their account to a positive balance. One example, Chime’s SpotMe® program, allows customers to overdraft up to $200 with no fees. The customer’s next deposit is applied to their negative balance, and once the negative balance is repaid, customers can give Chime an optional tip to help keep the service “free.”
Chime says: “Chime is a financial technology company, not a bank. Banking services provided by, and debit card issued by, The Bancorp Bank or Stride Bank, N.A.; Members FDIC. Eligibility requirements and overdraft limits apply. SpotMe won’t cover non-debit card purchases, including ATM withdrawals, ACH transfers, Pay Friends transfers or Chime Checkbook transactions.”
4 ways to avoid overdraft fees
Set up low balance alerts. Many banks offer an alert option so you’ll get a text, email or push notification if your account drops below a certain threshold. These alerts can help you be more mindful about your balance so that you can put more money into your account or spend less to avoid an overdraft.
Opt out of overdraft coverage. If your bank doesn’t offer overdraft protection — or if its only options cost money — you may want to opt out of overdraft coverage, in which case your bank will decline any transactions that would bring your account into the negative. Keep in mind that this option could put you in a sticky situation if you’re in an emergency and can’t make an important purchase because you don’t have overdraft coverage.
Look for a bank that has a more generous overdraft policy. Many banks are reducing or eliminating their overdraft fees, so if overdrafts are an issue for you, do some comparison shopping to see if there are better options available.
Consider getting a prepaid debit card. Prepaid debit cards are similar to gift cards in that you can put a set amount of money on the card, and once you run out, you can load it with more money. The prepaid debit card can’t be overdrawn because there isn’t any additional money to draw from once its balance has been spent.
Are Small-Business Loans Installment or Revolving?
A small-business loan provides funds to purchase supplies, expand your business and more. This type of funding can be either installment or revolving. Reviewing the credit terms of your loan offer will help you determine whether you’re being offered an installment loan or revolving credit.
Both types of loans can be found in the Small Business Administration, or SBA, loan program and at banks, credit unions and online lenders. While each can provide much-needed funding for your business, there are some key differences to keep in mind.
Installment loans vs. revolving credit
Installment loans provide a lump sum of money
An installment loan is a credit agreement where the borrower receives a specific amount of money at one time and then repays the lender a set amount at regular intervals over a fixed period of time. Typically, each payment includes a portion for interest and another amount to pay down the principal balance.
Business term loan is another common name for this type of loan. After the loan is paid off, the borrower typically must apply for a new loan if additional funds are needed.
Revolving credit provides flexible funds
A revolving loan is a credit agreement where the borrower can withdraw money as needed up to a preset limit and then repays the lender a portion of the balance at regular intervals. Each payment is based on the current balance, interest charges and applicable fees, if any. You pay interest only on the funds that you use — not the maximum limit.
A business line of credit is a common type of revolving credit. Revolving credit gives the borrower flexibility in determining when to withdraw money and how much. As long as the credit balance remains within the preset limit and you continue to make timely payments, you can continue to draw from the line again and again.
Differences between installment loans and revolving credit
The terms of a loan can vary depending on the type of loan, lender and your business’s credentials. Your loan may be a unique combination of terms. However, the following are some common differences between installment and revolving loan programs.
Withdraw as needed.
Minimum amount based on balance and interest with option to pay more.
Based on loan amount.
Based on current balance, not maximum loan limit.
Ability to renew
Not renewable, typically.
When to use an installment loan
Set loan amount is needed
If you’re confident in the loan amount you need, then an installment loan may be the right fit, especially if you need the money in a lump sum. For example, if you’re using the funds to make a one-time purchase, you’ll likely want an installment loan.
Long-term financing needs
Some term loans can offer you more time for repayment when compared with revolving credit. When you stretch your payments out over a longer period of time, it can mean a lower monthly payment. However, that trade-off typically means you’ll pay more in interest costs over the life of the loan.
Larger funding needs
If you’re looking to purchase property, equipment or other large-ticket items, there are a number of installment loans that can be used for this purpose. Revolving credit limits are often less than term loan maximums.
Preference for predictable payments
With a set monthly payment amount, it can be easier to budget for an installment loan compared with a revolving loan, where the payment varies depending on how much of the credit line you use.
When to use a revolving loan
Short-term financing needs
Revolving credit can be good to handle short-term cash shortages or to cover unexpected expenses. Some businesses use lines of credit as an emergency fund of sorts since they’ll pay interest only on the funds they use.
Fluctuations in cash flow
Businesses that experience major fluctuations in their cash flows may benefit from revolving credit. For example, seasonal businesses that don’t have consistent revenue throughout the year can use lines of credit to cover operational costs during their slow season.
Preference for flexible loan amount and payments
If you don’t know exactly how much money you need, then revolving credit will give you the option to qualify for a maximum amount but only withdraw funds as you need them. This way, you’ll pay interest only on the current amount owed.
Compare small-business loans
To see and compare loan options, check out NerdWallet’s list of best small-business loans. Our recommendations are based on the lender’s market scope and track record and on the needs of business owners, as well as rates and other factors, so you can make the right financing decision.
Advantages and Disadvantages of a Business Bank Loan
According to the Federal Reserve’s 2021 Small Business Credit Survey, banks remain the most common source of credit for small businesses — compared with options such as online lenders, community development financial institutions or credit unions.
You can use a business bank loan for a variety of purposes: working capital, real estate acquisition, equipment purchase or business expansion. To qualify for one of these small-business loans, however, you’ll likely need excellent credit and several years in business.
Before applying for a business loan from a bank, consider the following advantages and disadvantages.
Advantages of business bank loans
Flexible use of funds
Banks offer a range of different business loan products, including term loans, business lines of credit, equipment financing and commercial real estate loans, among other options. Unless you opt for a product that has a specific use case, like a business auto loan, for example, you can generally use a bank loan in a variety of ways to grow and expand your business.
When you submit your loan application, the bank may ask you to identify a purpose for the financing to evaluate the risk of lending to your business. Once you’re approved, however, the bank is unlikely to interfere if you change your intentions, as long as you make your payments. This flexibility is perhaps one of the biggest advantages when comparing debt versus equity financing.
Large loan amounts and competitive repayment terms
Bank loans are often available in amounts up to $1 million or more. Many online lenders, on the other hand, only offer financing in smaller amounts. Popular online lenders OnDeck and BlueVine, for example, both have maximum loan limits of $250,000.
Business loans from banks also tend to have long terms, up to 25 years in some cases. These loans usually have monthly repayment schedules, as opposed to daily or weekly repayments.
In comparison, online business loans typically have shorter repayment terms, ranging from a few months to a few years. Many of these loans require daily or weekly repayments.
Low interest rates
Banks typically offer small-business loans with the lowest interest rates. According to the most recent data from the Federal Reserve, the average business loan interest rates at banks range from 3.19% to 6.78%.
Although some online lenders can offer competitive rates, you’ll find that their products are generally more expensive than bank loans, with rates that range from 7% to 99%.
The interest rates you receive on a bank loan, or any small-business loan, however, can vary based on a number of factors, such as loan type, amount borrowed and your business’s qualifications, as well as any collateral you provide to back the loan. In general, the stronger your qualifications and the more collateral you can offer, the better rates you’ll be able to receive.
Relationship with a bank lender
Many banks provide ongoing support for their lending customers, such as business credit score tracking or a dedicated relationship manager to work with your business. Most banks also offer other types of financial products, such as business checking accounts, business credit cards and merchant services, if you prefer to use one institution for your financial needs.
Although some alternative lenders offer additional support and services, the Federal Reserve’s 2021 Small Business Credit Survey reports that businesses that receive financing are more satisfied with their experience with small banks (74%) and large banks (60%) compared with online lenders (25%).
Disadvantages of business bank loans
Intensive application process and slow to fund
To apply for a small-business loan from a bank, you’ll need to provide detailed paperwork that may include, but is not limited to, business and personal tax returns, business financial statements, a loan purpose statement, business organization documentation, a personal financial statement form and collateral information. You may have to visit a bank branch and work with a lending representative to complete and submit an application — although some banks offer online applications for certain business loan products.
The entire process, from application to funding, can take anywhere from several days to a few weeks, or even longer, depending on the type of loan and the bank. Some banks will also require you to open a business checking account with them before you can receive funds.
In comparison, alternative lenders typically have streamlined, online application processes that require minimal documentation. Many of these lenders also offer fast business loans — in some cases, funding applications within 24 hours.
Strict eligibility requirements
To qualify for a business loan from a bank, you’ll generally need strong personal credit (often a FICO score of over 700), several years in business and a track record of solid business revenue. Bank of America, for example, requires a minimum annual revenue of $100,000 for unsecured term loans and a minimum annual revenue of $250,000 for secured term loans.
Depending on the bank and the loan type, you may need to provide collateral, such as real estate or equipment, to secure your financing. Most banks will also require you to sign a personal guarantee that holds you personally responsible for the debt in the event that your business can’t pay.
Online lenders, on the other hand, have more flexible qualifications and some will work with startups or businesses with bad credit. To qualify for a business line of credit with Fundbox, for example, you only need six months in business, a credit score of 600 or higher and at least $100,000 in annual revenue.
Although online lenders may still require a personal guarantee, they’re less likely than banks to require physical collateral.
Find and compare small-business loans
Still trying to determine the right way to finance your business? Check out NerdWallet’s list of the best small-business loans for business owners.
Our recommendations are based on the market scope and track record of lenders, the needs of business owners, and an analysis of rates and other factors, so you can make the right financing decision.
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