The entrepreneurial spirit bites most people at least once in a lifetime in the form of a great idea. For a few, it bites regularly. So how do you know when the bite means starting a business versus seeking a good antibiotic?

Research, Research, Research

When a new idea pops up, the entrepreneur thinks they’ve discovered gold. That’s not a bad thing, but a quick reaction without researching reactions by target markets and the total viability of the idea spells a costly disaster in the making.

While your idea holds great attraction for you, knowing the marketability to potential customers demands a prototype, research for potential markets, test marketing and a manufacturing source that can develop your product cost effectively. This means understanding price points, competition, barriers to entry, product lifecycles and sources of capital.

Consider an Existing Business

Many times purchasing an existing business with great potential reduces the risk, especially if its’ target market fits with your new idea. If existing loyal markets of a business for sale provide potential for your new product, you win more time for bringing the new product to market. A good business broker helps you determine if an existing business fits your need. A going-concern may grant you sufficient cash flow for developing a new product prototype and test marketing and more importantly potential customers already loyal to you.

The sale of mortgage bond underwriter, Bear Stearns at a fire sale price leads the financial news this past week. Some small business entrepreneurs wrongly believe the near collapse of Bear Stearns isn’t relevant to them and their business plans and goals. While Bear Stearns’ customer markets, financial status and business plan fall way outside of the small entrepreneur, its business lessons deserve careful attention.

Yes, the failures of big businesses remain germane to small businesses. Smart small business owners and those planning to start a new business glean valuable information from the failures of others, whether big or small.

So what went wrong with Bear Stearns? Of course a small blog article can’t cover in-depth analysis but we can see some important overall principles.

• Bear Stearns ventured into a very risky behavior and got burnt. While new markets tempt the best of us wanting growth and rewards, research, an understanding and evaluation of the risk should rule every decision.
• Bear Stearns got too deep into risky behavior, to the point there was no way out. If a business finds they can risk capital, the amount of risk should equal the business’ ability to lose and survive.
• Rumors surfaced and Bear Stearns reacted slowly, keeping its customers in the dark as the market speculated.
• In the face of trouble, Bear Stearns continued its risky behavior, believing in its invincibility by believing its past performance of escaping disastrous consequences would continue.
• And, finally, Bear Stearns appeared to ignore its financial peril, even while Bear Stearns customers lost faith and fled in droves.

Customers’ perceptions (true or not) dictate a business’ survival. To ignore the customer is to kill the business. When a business becomes so confident that it stops listening, the business guarantees eventual failure. A certain amount of risk leads to growth; too much risk puts the entire business in peril.

In our previous posts (part II and part II) we discussed  some sources for business acquisition financing. This is the final segment of this subject.

Seller

If you purchase an existing business, the seller often offers financing for a portion of the purchase price. Expect better negotiation power with seller financing during a down-turn in the commercial real estate market.

In some cases seller financing is unavailable. When the business seller does offer financing, this solves not only solves the financing problem; but validates that the seller believes the business offers sufficient cash flow for supporting the new owner and his/her ability to replay the business acquisition loan. The seller stays invested for the duration of the loan, ensuring the buyer a willing assistant for business success. A seller jumping in the business boat with the buyer, now that’s great advertisement!

With seller financing, a buyer stills needs a plan for a down payment of approximately 25% to 50% of the purchase price. As with financial institution financing, expect market driven interest rates with seller financing, though with more flexibility.

Seller financing exacts a price. Just like a finance company or bank, the seller wants information about the buyer before making a financing commitment. The seller expects background information, including work experience, education and a sense of the business savvy of the buyer.

Prepare for selling your qualifications if you want seller financing. Just as you need a sales pitch about purchasing the business, the seller needs the confidence that you possess the business savvy for repaying the loan and not ruining the business. Assuming you want to purchase the business and expect seller financing, offer the seller your financial statement, list of references, a copy of your clean credit bureau report and any background information he might need. This demonstrates good faith, professionalism and an understanding that business is business.

Be forewarned that most financing from a seller comes in the form of a balloon note. A balloon note allows the seller’s removal from the business within a reasonable time and yet gives the buyer a reasonable time for repayment through business profits. If full repayment still isn’t possible, the buyer gains valuable time building a track record for financial institutions demonstrating the business is a reasonable risk. Sellers usually amortize notes with regular monthly payments kept low and a very large balloon payment at the end of the specified note term. Depending on the movement of interest rates, buyers may refinance the balloon note early once they’ve established a good credit and find a financial institution with more favorable rates and a longer term. Balloon notes offer both buyers and sellers a win-win situation.

401(K) and IRA Accounts

Recent rules developed by several large national CPA and attorney firms, and receiving approval of the IRS allow purchasing a business with 401(K) and IRA accounts without tax penalty to the account owner.

Funding a business acquisition with 401(K) and IRA accounts do involve legal and accounting fees. Best sources for information of these fees come directly from your lawyer, accountant or a reputable business broker; but expect the fees to be less than tax penalties for early withdrawal of these funds. My business brokerage firm, VRBusinessLakes, continually develops relationships with both attorney and CPA firms who specialize in these types of financing transactions. Let us know if we can make a referral.

A Trifecta!

The five new business financing sources listed are not mutually exclusive. Buyers can use one or a combination of these sources for a business acquisition. I recently handled a transaction in which three of the five sources were used to buy the business.

It’s called creative financing!

Yesterday we discussed Family Members  as a possible source for acquiring a business acquistion loan. Today we discuss two additional sources.

Banks

Thinking about a business loan? A bank automatically comes to mind as a good source. Unfortunately, most banks resist making business acquisition loans. Strange but true; especially because after starting a business, the banks actually seek your business! So why do banks avoid making business acquisition loans?

Banks may advertise business loans, but they usually mean for existing businesses. Unless you have a strong business plan, an even stronger former relationship with the bank and good collateral, count on hearing many reasons for declining your loan application to purchase a business. Your best banking source comes from those banks participating in the SBA loan program if they qualify you for an SBA guaranteed loan (see SBA as another source below).

Just because a bank turns down a business acquisition loan application, it doesn’t mean that you and your business plan aren’t viable. Banks practice risk aversion and turn down many new business purchase requests. When you finally secure a business acquisition loan, choke back the giggle when the same bank who denied your loan comes calling for your business. Consider handing them an application and telling them you will get back to them after they furnish documentation and you take it before the bank committee.

SBA (Small Business Administration)

The SBA offers business acquisition loans through approved lenders. Usually the SBA only guarantees loans made by financial institutions rather than directly making loans. This SBA guarantee program is called the SBA7(a) program.

Your local SBA office furnishes a list of approved lenders. The list includes both banks and other types of financial institutions such as GE Small Business Lending, AT&T Finance, CIT Group and others. In some cases the financial institutions provide for a starting working capital along with the actual price for acquiring the business. Expect a required down payment of approximately 15% to 25% of the loan amount; and plan on additional up-front fees for an appraisal and other costs. SBA approved lenders should be offering market competitive interest rates.

The downside of an SBA guaranteed loan includes piles of documentation and lots of detail along with a generous helping of patience. You benefit by providing all the required documentation in a quick and efficient manner. The sooner the completed package arrives at the SBA underwriter’s desk, the sooner you can expect an answer and start your new business. While waiting raises the frustration level, successfully obtaining a loan makes the outcome with the SBA a positive experience.

In Part III we discuss two more possible business aquisition loan sources.

Business Acquisition Financing:

In this series of articles we reveal five possible business financing sources for those interested in purchasing a business or franchise.

Family Members

Ever heard of the “rich uncle” theory? Some budding entrepreneurs find family members with sufficient liquid assets who willingly loan the down payment (or even the entire purchase price) to younger family members. Success in securing a loan usually takes a bit more than simply making a request. The older generation is more inclined to make loans to those demonstrating their initiative business savvy by researching possible businesses and then presenting a well thought-out business plan.

Stay tuned: next we will discuss more financing sources, Banks and the Small Business Administration (SBA).