So, you’ve decided that you want to take out a small business loan.
You know all about those pesky questions lenders will ask you, like, “What’s your annual revenue?” and, “What’s your credit score?” And you’ve got a billion documents prepared, from your bank statements to your balance sheets.
In other words, you’re completely prepared for this application. You’ve got as much of a chance as anyone else with the same business background and financials, right?
Well…not quite. Not all loan uses were created equal, and two loan uses, especially, are difficult to pick up funding for. If you’re on the lookout to take out a loan in order to buy an existing business or buy out a partner in your current business, you’ve got a bit of a challenge ahead.
But while it might not be easy, seeking funding to purchase a business or buy out a partner can be done. Read on to learn why it’s hard in the first place, and what you can do to compensate.
What’s the big deal? There are two main issues with taking out a loan to buy an existing business or buy out a partner. Let’s think like a lender and consider the common problems those two loan purposes lead to.
The Proof is in the Pudding
Lenders rely on past data to make assumptions about a borrower’s ability to repay his or her loan in the future. Or, to put it simply, lenders think this way: “If Jackie made good financial decisions with her business in the past, then she’ll probably make good decisions in the future.”
Your annual revenue, credit score, bank statements, balance sheets all act both as proof that you knew what you were doing in the past and insurance that you’ll continue to know what you’re doing in the future.
Jackie isn’t about to stop understanding her business’s financials once she secures that loan, instead, she’ll most likely use her extra capital wisely, and pay her lender back on time.
When it comes to purchasing a business or buying out a partner, this strategy that lenders use, and that everyone uses, really, isn’t quite as valid.
You see, the question is, how does a lender know whether Jackie would be good at running a restaurant? Sure, she’s proven herself capable of managing a car dealership, but different industries have their own challenges, and she’s never had to deal with small daily transactions and perishable inventory.
You get the idea. Past success can show your general financial and business acumen, but it doesn’t go as far.
The workaround to that challenge? It helps to have experience in the industry of the business you intend to purchase, or to be able to prove a similarity between your resume and that of an ideal owner.
The elephant-in-the-room question that a lender will be grappling with: "If the business you want to acquire didn’t succeed, why will yours?" Answer this convincingly, and you’ll be doing just fine.
And likewise for buying out a partner. How can our hypothetical lender be sure that it was Jackie who made her car dealership such a success, and not her partner, Bill?
For all the lender knows, Bill had all the contacts, the automotive wherewithal, and the strategic intuition that put their business into first gear, but it’s Jackie who wants to buy out Bill’s shares and take over the driver’s seat. That’s a big risk to take. Too big, for plenty of lenders.
Follow the Money
Usually, when you take out a business loan, you’ve got a plan figured out. You need (x) amount of cash to start that plan, but when it finishes, you’ll have made (x+y) back. More than enough to pay back your loan, plus interest.
In finance-speak, the return on investment (ROI) of your loan purpose will be greater than (or at the very least, equal to) the cost of your loan. It doesn’t make sense to take out a loan for a new piece of equipment if you don’t think that new piece of equipment will return enough money for you to pay back that loan, does it?
Your business plan will show exactly why it does make sense, in that case, or you can kiss that loan goodbye, most of the time.
Maybe you can see where this is heading. Both purchasing an existing business and buying out a current partner are loan purposes that don’t connect directly with a high ROI.
In each case, that money the lender gives you? It goes straight to the owner or partner you’re taking the place of, who immediately departs the scene, pockets lined with money that you can’t use to buy equipment, stock inventory, set up a marketing plan, or do anything at all with.
So in conclusion, having a solid financial and business background might not be enough, you may have to get persuasive with your arguments if you’re going to convince a lender to back one of these loan purposes. Good luck!