Banks often use the Small Business Administration 7a program to guarantee acquisition loans for small businesses.  Because small business ventures face unique risks, most do not qualify for conventional bank financing.  In most states, the SBA program is the only option; however, here in California a less well known alternative called the California Loan Guarantee Program is also available.

California’s program is not new. Our state has been offering loan guarantees since 1968.  It is administered by the State Business, Transportation and Housing Agency in partnership with the Governor’s Office of Business and Economic Development.  But it is much smaller than the SBA program.  Our state program approved over $187 million in loans in 2015/16 while the SBA programs (7a and 504) approved over $5 billion in California loans in 2016.

One reason that the State program is not always a first choice is because of the shorter loan term of 7 years as compared to 10 years for the SBA program.  A 7 year loan results in higher monthly payments and more stress on the business.

Comparison of California Loan Guarantee and SBA 7a programs

However, in specific cases the State Program has some clear advantages over the SBA program.  Generally the State Program requires less paperwork and the qualification requirements are not as stringent as the SBA program.  For example, the SBA program requires that the business seller completely divest of his interest in the business and not play a formal role in the operations of the business for more than 12 months after it’s sold.  The California program, on the other hand, does not have these requirements which gives participating banks more latitude in structuring deals.

Not all banks participate in both programs so if you are a prospective buyer in need of a loan it is a good idea to shop around.  The bank providing the loan must provide justification that the loan is helping to create or maintain jobs in California, which is typically not an issue when the loan is intended to fund an acquisition of a small business.

Contact Adam Wiskind at awiskind@exitstrategiesgroup.com with any questions or for help buying, financing or selling a California business.

Of the many considerations when purchasing a small business, one of the most important is how to finance it.  Even if you have all of the cash you need to buy a business, as a smart investor you will consider whether you are better off borrowing some of the money or bringing in an equity partner to spread the risk.

Each source of business acquisition financing has its benefits and drawbacks. Before you identify a business that meets your acquisition criteria you should understand how large a business you can afford and where you can secure the funds. You can mix and match the financing strategies below depending on your needs and qualifications, and the deal’s size and complexity:

• Family and friends.   If you don’t have the initial capital to acquire a business, consider asking friends and family for help. Those who are close to you and believe in you may be willing to take a chance on your business. The investment could be a gift, a loan or an equity investment in the business. Each have pluses and minuses, and each should be recorded in writing, in many cases a legal document. While a gift may be the most straight forward way for your friends and family to support you, many experts suggest loans as the optimal way for personal relationships to invest in your business plans because there are clear expectations and repayment terms. If you accept an equity investment you are literally turning a friend or family-member into a business partner. This type of relationship can be fraught with challenges and misunderstandings so be sure to clearly define the terms of the investment.

• Seller financing.   Consider asking the seller of the business if he or she can provide financing for the sale of all or some of it. The benefit to the seller is that they may make more on a loan to you than alternative investments available to them. Also by taking a note rather than cash they may be able to defer some of the taxes on the sale of the business. There are benefits for the buyer too. In some cases, sellers may provide more reasonable interest rate than the banks. Also sellers that retain a note still have an interest in the success of what was once their business. This can provide you with a built-in source for advice and guidance.

• Bank Loan.   To obtain a loan from a bank to purchase a business both the target business and the buyer must be able to qualify. The business should have positive cash flow, solid management experience, industry expertise and a strong credit report. You, as the buyer, must have good credit (at least 640 FICO score), business management experience and in some cases personal collateral to back the loan. Many lenders across the country offer small-business loans guaranteed by the U.S. Small Business Administration (SBA) 7a program. These loans provide lenient and flexible financing for qualifying borrowers. SBA loans have low down payment requirements (as low as 10% on some deals), are structured without balloon payments and have up to 10 year terms which keep loan payments low.

One substantial downside to the SBA loans is that they require personal guarantees, putting you personally on the hook for any defaults by the company. Typical bank loans don’t always have this requirement for businesses generating enough cash flow. SBA 7a loans can have higher interest rates than traditional bank loans. They also require more paperwork and a greater time investment in the documentation and approval process.

• 401k/IRA.   An often overlooked source of acquisition funding is your personal 401k or IRA. The benefit of this approach is that there is no penalty for early withdrawal nor requirements to repay the funds back into your retirement vehicle. The Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA) include provisions that permit individuals to invest their retirement funds in stock in their own companies. Often called ROBS (Rollover for Business Start-Ups) the process is fairly straightforward but there are a few legal hurdles, so consult a professional. Also be prudent with your investment as you’ll be risking your retirement savings in your business.

It is important to have a financing strategy prior to making an offer to purchase a business. Contact Adam Wiskind, M&A Broker with Exit Strategies Group, Inc. to discuss your financing options. He can be reached at (707) 781 8744 or awiskind@exitstrategiesgroup.com.

In 2007 I found myself at a crossroads. After almost twenty years on a steady career path, I felt it was time for a change. The problem was that I didn’t know what I wanted to do next. I considered going into consulting, did the mandatory networking with old contacts, and even gave serious thought about doing a start-up. But I didn’t have that one great “do what you love” or “change the world” idea.

It was at that point that I started seriously considering buying an established business in California. I spent a couple of hours each day scanning various business for sale websites, and made quite a few inquiries. I learned quickly that there are many great businesses out there, and that people sell for all kinds of reasons. There was such a variety of businesses to explore that it was much easier for me to eliminate business categories that I didn’t want to look at (for me it was restaurants) than to focus my search on any one particular type of business.

I ultimately came across an interesting company that had established an ecommerce presence selling identification and security products – ID cards and readers, printers, convention badges, lanyards, etc. Despite having no prior experience in the industry, it was an easy enough business to understand and to envision how I could make it work. I had done my homework and knew how much cash flow I needed from a business and how large a transaction I could pull off, and this one fit within my parameters. I made an offer, and after a short negotiation we reached agreement on price and deal structure. As of January 2008, I was the proud owner of my own business.

My wife and I ran the business for seven years until we were ultimately bought out by another firm in our industry. After all of the transaction related taxes and other costs, our initial investment in the business had grown by more than 6x during our seven-year ownership. That works out to an annual rate of return of over 30%. In addition, we were able to pay ourselves a decent salary throughout the time we owned the business. There are not many other investments that can pay your salary and grow your net worth at the same time.

In case you missed it, we bought the business in January 2008 – just a few months before the biggest financial crisis in a generation hit. Our timing could not have been worse. Because of the financial crisis, we didn’t come anywhere close to hitting the sales and profit targets that I had projected. In fact, it wasn’t until 2011 that we achieved total sales greater than 2007 – the year before we became the owners. But despite the bad timing, purchasing a business was the best financial decision I ever made.

Mark Soeth is an M&A Advisor with Exit Strategies Group’s Sacramento California office.