What I’m reading
I just finished Inspired by Marty Cagan.
It’s a book about the product management profession and how to build amazing products. Although the book bends heavily towards coaching product managers who work at startups on how to be better at their jobs, you should still consider reading the book if you are a founder who sells products, and maybe even services.
If you follow some of the author’s suggestions around customer research you can be sure that your product launches will be much smoother and more likely to find product-market fit.
In August, I talked about the growth in the number of people using search funds to finance their dream of buying and operating a business.
What’s great about using a search fund is that you are using someone else’s money, for the most part.
When most people talk about search funds, they are talking about using investor capital. The searcher pulls together a group of investors, gets them to commit a certain amount of capital, and then goes in search of a business to purchase. Once bought, the searcher becomes the CEO of the business and the investors start getting returns on their investment.
Leveraging investor capital isn’t the only way to buy a business with zero money of your own.
Up until recently, Small Business Administration (SBA) loans required that the borrower, the searcher, inject cash into the deal. The minimum was 10% down at one point. This means, that if you were buying a $500,000 business, the searcher had to put $50,000 in cash into the deal. Which is no small sum. When deals involved real estate in the purchase, that cash injection was even larger.
Fortunately, the SBA was been lowering its guidelines over time.
Seller financing has always been an option with SBA loans. When buying an existing business you could use a combination of an SBA loan, some cash injection from the buyer, and have the seller carry a note to cover the rest. However, changes to the SBA’s guidelines now allow the seller to carry 5% of the 10% equity injection.
Meaning, that the SBA can finance 90%, the buyer puts in 5%, and the seller carries a note (owed by the buyer) for the remaining 5%. To do this, the seller’s note has to be on what is called full standby. Meaning, the seller can’t be paid back for their 5% until the loan itself has been paid in full.
Essentially, the seller is becoming a lender of sorts and is in a secondary position to the SBA loan.
Back to our earlier example, this means that on a $500,000 purchase, the SBA loan could be for $450,000, the buyer would inject $25,000, and the seller financing would be for $25,000.
One more thing to keep in mind, the SBA sets guidelines for lenders. However, SBA-approved lenders who are part of the PLP (Preferred Lending Program) are allowed to approve, or decline, SBA loans based on their own underwriting criteria. This means, that just because the SBA program can lend up to 90% doesn’t mean a lender will approve the loan up to that amount. If they feel like there are risk characteristics that concern them, they will likely approve the loan for a lower amount and require the buyer to come up with the difference.
The above scenario happens most often when one of three issues arises: 1) the business isn’t cash flowing well enough to prove repayment; 2) there isn’t sufficient collateral to secure the loan; 3) the buyer isn’t in as strong of a financial position.
While $25,000 down isn’t zero down, it is pretty low. Imagine using investor capital or an SBA loan to purchase a $500,000 that has high margins and is kicking off six figures in revenue to the owner. If you are willing to put in the work and you have the skills to grow a business, then purchasing a business could be a quick path toward entrepreneurship.
The great thing about buying an existing business, assuming you do your due diligence well and don’t buy a bad business, is that you don’t have to go through all of the toll that comes from trying to get a new business off the ground.
If you are considering buying a business, there are a few resources that you can browse:
Even if you don’t buy a business, just going through the process of identifying good businesses, interviewing sellers, reviewing their financials, and more is a great education.
If you'd like to book some time to talk through the process and my fees, book some time with me here.