An important part of buying a business is figuring out how to pay for it. Lenders are changing the way they do business which has fueled a demand for alternative financing opportunities. There are a variety of loan options available including commercial loans, private capital, and hard money loans. It is necessary to determine which type of loan is going to be the best fit for you. It is advisable to consult with a financing professional when trying to decide which option to choose. Let’s further examine the definitions of the different types of loans as well as their advantages and disadvantages.
Commercial loans are sometimes referred to as conventional or traditional loans. These loans are a debt based funding agreement between a borrower and a financial institution. Borrowers must go through a loan approval process when applying for a loan.
An alternative financing option is private capital. Private capital comes from an individual investor, a private capital group or an angel investor. This loan is secured with a contract or agreement and in some cases the investor is given a percentage of the company in exchange for their funds.
Hard Money Loans
Hard money loans are issued by private investors or companies. Hard money loans are asset based. The borrower puts up collateral in order to receive funds. The collateral is typically the value of their real estate.
Which One Should You Choose?
Trying to determine which type of loan is the right fit for your business financing needs can be difficult especially if you are going it alone. Going it alone can backfire and result in lost or bad deals. Due to my 25+ years in this business, I highly recommend working with a financing professional. A niche specialty loan broker will help evaluate your financing needs and make a recommendation that is based on their expertise.
If you are going to attempt to go at this alone, you need to contemplate each option and your evaluate your situation. Most borrowers get started by applying for a conventional loan and seeing if they get approved or not. If they are not approved they will then seek out alternative financing opportunities like private capital or hard money loans. Looking at one type of loan just because you did not get the other one is not always the best strategy.
There are advantages and disadvantages to each type of loan. Depending on the situation what may be an advantage for one person may be a disadvantage to another and vice versa.
Concerning conventional loans, one disadvantage to them is that you will be starting off your business in debt. A portion of your profits will have to be used to pay off the loan according to the payment schedule. Be sure to find a loan with the best rates and terms if you go this route.
Private capital and hard money loans are not readily available. However, with these types of loans you do not have to go through an approval process. The agreement is simply a contract between the investor and the business owner. Some may view giving up a percentage of their company as a disadvantage, but if you can find the right investor, one advantage may be that the lender can also become a mentor as they have a stake in the company too.
A disadvantage to a hard money loan is that interest rates are usually higher than a commercial loan and that is because the lender is taking a greater risk. Also, typically, hard money loans are designed as a short term loan solution.
In summary, each loan option has their pros and cons. I strongly suggest consulting with a professional to help you determine which type of business financing is the best fit for you!
About The Author: Peter Siegel, MBA is the Founder & President of BizBen.com, a website for businesses for sale, businesses wanted to buy, resources, & articles, and the BizBenNetwork Online Community. He advises and consults with business buyers, business sellers/owners, brokers, agents, investors, & advisors on a daily basis. Reach him direct at 866-270-6278 to discuss strategies regarding buying, selling, (or financing a purchase of) small to mid-sized businesses.