How to Finance a Business Acquisition

How to Finance a Business Acquisition

Acquiring an existing business -- with its established revenue, customers, employees, and systems -- is often a lower-risk path to ownership than starting from scratch. But the financing side is where most acquisition deals stall or fall apart entirely. This guide covers the four main funding sources, how they fit together, the SBA 7(a) details that matter, and a step-by-step process to get from letter of intent to funded deal.

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The Four Main Funding Sources

Most business acquisitions are funded by a combination of sources, not a single one. Here is how the typical capital stack looks:

The SBA requires the buyer to contribute a minimum 10% equity injection from personal funds (not borrowed money). Seller financing can count toward the remaining gap, but it cannot replace the buyer's cash equity.

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SBA 7(a) for Acquisitions: The Details That Matter

The SBA 7(a) is the most common financing tool for business acquisitions under $5 million. Here are the specifics:

### What Lenders Actually Underwrite

SBA acquisition lenders focus on three things:

1. Historical cash flow of the target business. Can the business -- as it exists today -- service the proposed debt? Lenders look at seller's discretionary earnings (SDE) or adjusted EBITDA, not gross revenue.
2. Buyer qualifications. Industry experience, management capability, personal credit (typically 680+), and liquidity.
3. Deal structure. Purchase price relative to cash flow, adequacy of the equity injection, and whether seller financing terms are SBA-compliant.

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DSCR: The Number That Makes or Breaks Your Deal

Debt Service Coverage Ratio (DSCR) is the single most important metric in acquisition financing. It answers: can the business generate enough cash to pay its debts? DSCR = Adjusted Net Operating Income / Total Annual Debt Service

Lenders require a minimum 1.25x DSCR -- meaning for every $1.00 in debt payments, the business must generate $1.25 in available cash flow.

Worked Example: $900,000 Acquisition

A 2.05x DSCR is strong. The business generates more than double the cash needed to service debt, leaving comfortable margin for working capital, owner compensation, and unexpected dips. Deals below 1.25x will not get approved; deals above 1.50x get favorable terms.

Another example at a tighter margin:

A 1.38x DSCR passes the 1.25x minimum but is tight. The lender may require additional collateral, a larger equity injection, or a lower purchase price.

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Seller Financing: How It Works and Why It Matters

Seller financing is when the business seller agrees to carry a portion of the purchase price as a loan to the buyer. It is not optional in most SBA acquisition deals -- it is expected. Here is why:

Why lenders want to see seller financing:

• It signals the seller believes the business can service the debt (they have skin in the game post-sale)
• It reduces the SBA lender's exposure
• It fills the capital stack gap between the SBA loan and the buyer's equity injection

Seller Financing Structures for SBA Deals

SBA lenders have strict rules about how seller financing interacts with the senior SBA loan:

Full standby (most common for SBA deals):

• The seller note is on full standby for a minimum of 24 months -- meaning no payments of principal or interest during the standby period
• After the standby period, payments begin (typically 5-7 year amortization at 5-8% interest)
• The seller note is subordinate to the SBA loan in all respects: no payments before SBA is current, no acceleration rights that override SBA

Why full standby matters: The SBA lender calculates DSCR based only on the SBA loan payments during the standby period. Once seller note payments begin, the business must be able to service both -- but by then, the buyer has had 24 months to grow revenue and stabilize operations.

Typical Seller Note Terms

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Step-by-Step Acquisition Process

Step 1: Identify and Evaluate the Target (Weeks 1-4)

• Review financial statements, tax returns (3 years), and normalized earnings
• Calculate seller's discretionary earnings (SDE) or adjusted EBITDA
• Assess industry, customer concentration, key-person risk, and reason for sale
• Determine a fair purchase price (typically 2-4x SDE for small businesses)

Step 2: Submit Letter of Intent (Week 4-5)

• Non-binding LOI outlines purchase price, deal structure, due diligence period, and key terms
• Seller financing terms should be discussed and agreed to at this stage
• LOI typically includes a 60-90 day exclusivity period

Step 3: Secure SBA Pre-Qualification (Weeks 5-7)

• Submit buyer resume, personal financial statement, and target business financials to an SBA Preferred Lender
• Lender provides preliminary approval and outlines loan terms
• This is not a commitment but establishes feasibility and identifies deal-breakers early

Step 4: Conduct Due Diligence (Weeks 5-10)

• Deep dive into financials: verify revenue, expenses, and cash flow with source documents
• Review customer contracts, vendor agreements, employee obligations
• Assess lease terms (if applicable), IP ownership, pending litigation
• Quality of earnings analysis for larger deals

Step 5: Complete SBA Loan Application (Weeks 7-10)

• Full application with all supporting documentation (business plan, projections, personal financials, tax returns)
• Lender orders appraisal (if real estate is included) and completes underwriting
• SBA reviews and issues authorization (PLP lenders can authorize in-house)

Step 6: Negotiate Final Purchase Agreement (Weeks 10-12)

• Asset purchase agreement (APA) or stock purchase agreement detailing all terms
• Seller financing note and subordination agreement
• Non-compete, transition assistance, and training period terms
• Legal counsel for both parties reviews and finalizes

Step 7: Close and Fund (Weeks 12-14)

• SBA loan closes, funds are distributed
• Seller financing note is executed
• Ownership transfers, transition period begins
• Buyer takes operational control

Total timeline: 60-90 days from LOI to closing for a well-organized deal. Delays are most commonly caused by incomplete buyer documentation, seller financials that do not reconcile, or appraisal issues.

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Down Payment Requirements by Deal Type

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Common Pitfalls That Kill Deals

1. Overpaying. A purchase price that produces a DSCR below 1.25x will not get SBA approval regardless of how much you love the business. Start with the cash flow and work backward to the price the numbers support.

1. Undisclosed liabilities. Tax liens, pending lawsuits, environmental issues, or unreported debts discovered during due diligence. Always run a UCC search and review the balance sheet carefully.

1. Insufficient equity injection. The SBA requires minimum 10% from the buyer's personal funds. Borrowed money, seller gifts, and third-party equity do not count. Start saving or plan accordingly.

1. Seller financing that does not comply with SBA rules. If the seller note is not on full standby for 24+ months and fully subordinate to the SBA lender, the deal will stall during SBA review.

1. Customer concentration. If one customer accounts for more than 20-25% of revenue, lenders view this as a risk. Address it in your business plan and show a plan to diversify.

1. Key-person dependency. If the business cannot function without the seller, the transition plan is critical. Lenders want to see a 90-day+ transition and training period.

1. Incomplete documentation. Missing a single year of tax returns, an unsigned personal financial statement, or an outdated rent roll can add weeks to the timeline.

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Frequently Asked Questions

1. How much do I need as a down payment to buy a business?

The SBA requires a minimum 10% equity injection from the buyer's personal funds. Some deals require 15-20%, particularly if you are new to the industry or the business has risk factors. The equity injection must come from verifiable personal sources -- not borrowed money.

2. Can I buy a business with no money down?

Not with SBA financing. The minimum 10% equity injection is required. Some creative structures use 401(k) rollovers (ROBS), retirement fund distributions, or home equity to generate the down payment, but you need cash or liquid assets equivalent to at least 10% of the total project cost.

3. How long does it take to close on a business acquisition?

Typical timeline is 60-90 days from letter of intent to closing. Well-organized deals with clean financials and experienced advisors can close in 60 days. Deals with complex structures, SBA review delays, or documentation gaps can take 90-120 days.

4. Does the seller have to provide financing?

It is not legally required, but most SBA lenders strongly prefer or require seller financing as part of the deal structure. It signals the seller's confidence in the business and reduces lender exposure. Expect to negotiate 5-20% of the purchase price as a seller note.

5. What if the business I want to buy includes real estate?

SBA 7(a) can finance both the business and the real estate in a single loan (up to $5M total). The real estate must be at least 51% owner-occupied. Including real estate typically extends the loan term to 25 years for the real estate portion and 10 years for the business portion (blended). This can improve monthly cash flow significantly.

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Ready to finance your business acquisition? Start your application and we will match you with SBA-preferred lenders who specialize in acquisition deals. Already have a deal under LOI? Learn about seller financing to structure the seller note correctly.