Talking to lenders before you find a business

Most buyers call a lender once they've found a business they like. It's better to call months earlier. A few conversations before you have a deal tell you how much you could realistically borrow, what a lender will want from you, and which lenders actually know how to finance a business purchase. They also make you a more believable buyer when you sit down with an owner.

Why early beats late

When you find a company and start talking price, things move. An owner who's ready to sell won't wait weeks while you learn how business loans work. If you've already talked with lenders, you know your range, you have your paperwork ready, and you know whom to call. That's the difference between promising to look into financing and being able to say a lender has already seen your numbers.

What a first conversation tells you

How big a company you can buy. Many business purchases are financed with an SBA 7(a) loan: a bank loan that the U.S. Small Business Administration partly guarantees. The program can be used for a change of ownership, with loans up to $5 million. When you buy a whole company this way, SBA rules require at least 10% of the total cost to come from you. Add about 4% for closing costs, and plan on cash for about 14% of the price.

Say you have $250,000 to put in. That supports a price of up to about $1.8 million ($250,000 ÷ 0.14). A lender will tell you whether that math holds for you, or whether something like your credit or experience changes it.

What the business will need to earn. The lender also checks that the company can carry the loan. Its owner earnings (profit plus what the owner pays themselves, before loan payments and taxes), after your salary, should be at least 1.25 times the yearly loan payment. At about 10.25% interest over 10 years, every dollar you borrow costs about 16 cents a year. So a company priced at $1.5 million means a loan of about $1.35 million, which costs about $216,000 a year, and the company would need about $270,000 left after your salary. Knowing this early keeps you from falling for a company that can't support the price.

How they see your background. Lenders want to know you can run the company. They'll ask about the people, money and operations you've managed and any experience in the industry. Some lenders are comfortable with a manager from a related field buying an HVAC company; others want hands-on industry experience. Better to learn that before you spend months on a company in an industry where your lender would hesitate.

What they'd need from you. Every lender has its own list. Ask for it now so you're not scrambling later.

Finding lenders who know business purchases

Not every bank does these loans often, and a lender who mostly finances buildings may find a business purchase unfamiliar. Some ways to find the right ones:

• The SBA's Lender Match tool on sba.gov. You answer a few questions, and about two business days later the SBA gives you a summary of lenders interested in talking with you. It doesn't guarantee a match or a loan.
• Referrals from accountants and attorneys who work on business purchases. They know which lenders close and which ones stall.
• Other owners who have bought a company. Ask whom they used and whether they'd use them again.

Talking to two or three lenders is reasonable. The best fit isn't always the bank down the street.

Questions to ask

1. How many loans to buy a business have you closed in the last year, and at what sizes?
2. Do you make these loans under the SBA's Preferred Lenders Program? Lenders with that authority can approve SBA loans themselves rather than sending each one to the SBA for review.
3. How would you view my experience for the industries on my list?
4. Are there industries you avoid?
5. What would you need from me now, and what later?
6. How do you treat a loan from the seller for part of the price?
7. How much cash would you want me to have left after closing?
8. What fees would there be, and which costs come before closing?
9. How long does it usually take from a complete application to closing?
10. Who would be my contact, and who makes the final decision?

What to bring

• A one-page resume focused on the people, budgets and operations you've been responsible for.
• A personal financial statement listing what you own and what you owe. The SBA's version is Form 413, which it uses for 7(a) loans to judge repayment ability and creditworthiness. Your lender may have its own.
• Your recent personal tax returns. Ask how many years they want.
• Where your cash would come from: savings, retirement accounts, money from family. Ask how each would be treated.
• A short description of what you're looking for: industries, size, area and the salary you need.
• A fresh look at your credit. Check your credit reports before the lender does, and ask whether they'll pull your credit at this stage.

If you're still working while you search, your current job affects how a lender looks at your income and your plans; searching while employed covers how to handle that.

What a lender can't tell you yet

No lender can approve a loan before there's a business. Approval depends on the company's tax returns, its earnings, the price and the terms. Some lenders will write a short letter after reviewing your background. It's not a commitment, but it can help an owner take you seriously. Don't mistake it for an approval, and don't present it to an owner as one.

Ask early, too, about what you'd sign personally. Business purchase loans usually come with a personal guarantee, and sometimes your home is involved. Personal guarantees and collateral explains what that means before you're in the middle of a deal.

Keep them in the loop

Lenders remember buyers who stay in touch. When you find a promising company, send your lender the basics early: industry, price, rough earnings. Before you sign an offer, check that the structure you're proposing is one they can finance. An owner is far more likely to take an offer seriously when your financing is already lined up behind it.

What to do this week

1. Check your credit reports and correct any errors.
2. Add up the cash you could really put in, and where each dollar would come from.
3. Write a one-page resume and fill out a personal financial statement.
4. Find two or three lenders that regularly finance business purchases, through Lender Match or referrals.
5. Book a 30-minute call with each, ask the questions above, and compare the answers side by side.

None of this commits you to anything. It just means that when the right company comes along, you'll be ready to move.