Where Do Entrepreneurs Get the Money to Buy a Business?
One of the biggest challenges for an entrepreneur is finding the money to do a deal.
I spoke to the Entrepreneurship Through Acquisition class at the University of Illinois Geis College of Business last week. They are using my book as one of their texts, so I was invited to share my experiences representing clients who became entrepreneurs by acquiring a business.
The professor asked me where most of my clients get the money to buy a business. In particular, he wanted to know whether any of my clients had obtained money from a search fund. There are search funds out there, such as the one associated with Harvard Business School, where entrepreneurs can obtain funding to acquire a business they have identified as a ripe target.
I have never had a client obtain acquisition money from a search fund, however. That could be because there isn't a search fund located near me, so my clients might not be aware such a resource exists. But the professor indicated that another guest speaker - a business broker working in a large metropolitan area near search funds - had done very few deals where search fund money was involved.
So, where do most of my clients get the money to buy a business? Most of them fund the acquisition with a combination of three sources:
Personal finances (e.g., savings)
These sources are fluid - as the amount of one goes up, the amounts of the others can go down, but there are limits. For example, a client with a significant amount of personal money to put toward the purchase price likely will need a smaller commercial loan and less seller financing. That makes the deal more attractive to commercial lenders and sellers. But the opposite is not necessarily true because commercial lenders and sellers have their limits. If an entrepreneur has very little personal money to inject into the deal, a commercial lender and seller might not be willing to extend enough credit to make up the difference because the entrepreneur is too much of a credit risk.
What about relying on seller financing for most of the purchase price? Some entrepreneurs want to skip the commercial lender (e.g., because they cannot qualify for a loan) and persuade the seller to become the bank by financing almost all of the purchase price. This is unlikely and I've seen it done only a few times in very small deals. A seller typically is unwilling to finance a large portion of the purchase price because they want their money sooner, rather than later, and they don't want to risk not getting paid. If you cannot get a commercial loan, that's a red flag to a seller. In those instances where I've seen this work, there usually is some other factor involved, such as a personal relationship between the seller and buyer (e.g., the buyer is a long-time employee or customer of the business) or when the seller cannot find another buyer and is anxious to sell.
What about getting money from investors to combine with commercial loans and seller financing (e.g., a private placement)? It's done, but I have represented only a small percentage of entrepreneurs who have been able to raise capital this way. The entrepreneur will need to find the investors, sell them on the investment, and negotiate the investment deal with each of them, all while complying with applicable federal and state securities regulations. It takes time to raise money this way because there are a lot of moving parts. It also can complicate how the business is run after the business acquisition because there will be more people potentially involved in decisions - i.e., the entrepreneur gives up some control over the business in order to get money for the acquisition.
Look at it this way: if you don't have a good amount of personal money to inject into the deal and cannot qualify for a commercial loan, then you probably can't rely on seller financing to make up the difference. In that case, you will need to look to outside investors or search funds (a type of outside investor), but raising capital from those sources usually is a longshot.