Author Topic: How should I finance a business purchase?  (Read 4474 times)

wizofloz

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How should I finance a business purchase?
« on: July 30, 2014, 08:54:23 AM »
I have finally read every blog post, now I have a question. I have found a business I would like to purchase. I have spent the past four months researching and writing a business plan and have decided it is a worthwhile purchase. Below is my situation and options that I have come up with. I am interested to hear opinions as well as options I might not be aware of.

Age: 32
Married with 2 young kids
$160,000 remaining mortgage on $240,000 house
$48,000 remaining mortgage on $120,000 second house (this is nearly complete with a full remodel, future options below)
~$300,000 in tax deferred retirement accounts
After tax savings ~$10,000

My ideas for business financing:
Business purchase price $85,000
Total funds needed for acquisition $100,000

Option 1:
Bank loan. They are offering $85,000 at 5% for 15 years requiring both homes as collateral. This requires me bringing in 15k which is not a problem. This results in approximately a $675/month loan payment.

Option 2:
Cash out refinance of both homes. Using 80% of the home value this would provide about $80,000 cash at a rate closer to 4.25%. However this would result in increasing my current mortgage rates from their 3.125%. I would also begin renting out the second home if I go this route. The rent would cover the second home mortgage with about $130/month extra to cover maintenance. I would still bring in 15k which leaves a 5k deficiency but I can figure out a way to make that work, 85k is the listed sale price not the agreed upon purchase price.

Option 3:
Sell the second home and finance the remaining need. The biggest problem with this option is the tax bill associated with selling the house. I have never lived there so I won't have the tax advantages of selling a primary residence.

I am leaning toward option 2 since it doesn't require a commercial loan, the interest is lower and tax deductible, should provide the opportunity to have someone else pay part of the bill and doesn't give me a large tax bill. I have looked into Roll Over Business Startups but I'm not in a huge hurry to tap into my retirement. I will be quitting my current job to run the business full time so opening an individual 401k and rolling over my retirement then taking a 50k loan is a possibility but I haven't looked into that very much.

That is where I am at. Thoughts? Opinions? Suggestions? I'd like to hear them all.

Cpa Cat

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Re: How should I finance a business purchase?
« Reply #1 on: July 30, 2014, 09:22:37 AM »
I like option 1. I like a business loan that is separate from your personal lines of credit. It's easy to deal with on the tax front.

Your business makes the payments. You deduct the interest on Sch C or the business' tax return. Done.

It's nice, clean and separate.

You also begin a business-lending history, which makes it easier to pick up a business LoC in the future.

wizofloz

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Re: How should I finance a business purchase?
« Reply #2 on: July 30, 2014, 09:35:12 AM »
Thank you Cpa Cat. I hadn't considered the business credit history. If I make business loan payments to myself is there a way to report that as a commercial loan payment?

Cpa Cat

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Re: How should I finance a business purchase?
« Reply #3 on: July 30, 2014, 09:58:48 AM »
Yes. There is. And people do it. But it does put you in a grey area of: Are you making a capital contribution or a loan? Is it a capital contribution that only looks like a loan?

There are various formalities that you would want to observe and the careful separation of business funds and personal funds. If you're going to go that route, then you should consult with a CPA.

You'd want to get your ducks in a row so that if you were ever called upon to defend it to the IRS, you had everything in place.

I want to be clear that there's nothing shady about using your mortgage to fund your business purchase. You just want to make sure that a 3 year old could connect the dots between the funds from your refinance to your business purchase to the loan repayments.

lhamo

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Re: How should I finance a business purchase?
« Reply #4 on: July 30, 2014, 10:15:54 AM »
Is there any possibility of moving back in to the second house and selling the first one? 

wizofloz

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Re: How should I finance a business purchase?
« Reply #5 on: July 30, 2014, 10:21:29 AM »
Moving into the second home would be an option, and even preferred, if I were single, however it is in a small town and my wife has vetoed that option. I will mention it to her again, adding it was suggested by the Mustachians.

Chunk

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Re: How should I finance a business purchase?
« Reply #6 on: July 30, 2014, 10:42:42 AM »
Long time lurker here. I have spent the last 8 or 9 years buying, improving, and selling businesses. Maybe some of my experiences can help you out.

I consider myself to be very good at what I do - BUT, not every business I have purchased has worked out well.

To give you an idea of what I mean, here's the gist. In December of 2012, I bought the business that is currently my biggest business. I paid $5000 for it and it was a business that wasn't earning money yet. I now have that business producing between $30,000 and $40,000 per month most months.

That sounds great right? Well... Earlier this year I bought another business for about the same price and it was already making money. The problem is that with that business, I just haven't been able to get it to work. I have spent a lot of time and money on it and over the past six months, I have only lost money on it. Basically, it's a business that can make a small amount of money if I put all of my time into it, and isn't profitable if I have other people trying to run it.

The point is this. I think I have pretty good instincts and most of the time when I buy a business, it works. Sometimes, it doesn't. For this reason, I would never risk my house to buy a business. There will always be other businesses to buy and it sounds to me like right now, you are very close (but not quite) in the position you need to be in to buy this one.

I'm not the kind of guy who presses my opinion on other people and ultimately this is your decision and I'm sure you'll make the right one for you. I just wanted to give you an outside perspective based on what I've seen in my businesses.

I do have a question for you though, since this is a somewhat large purchase price. What do the books look like in this business? What are its gross and net revenues? Also, how much expertise do you have with the niche the business is in?

wizofloz

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Re: How should I finance a business purchase?
« Reply #7 on: July 30, 2014, 11:32:26 AM »
Chunk, I don't look at using my homes equity to finance a business as any more risky than other financing options. In the event of a complete failure I'm not going to lose my house, I could either sell it or in a real pinch use my retirement account to right the ship. The business I plan on buying is a stable company with over 20 years of history. The industry is directly related to my background in science and mathematics. The main thing this company needs is a new owner who is willing to scale it up.

As far as the financials they are decent, operating in the low 30's for net percent. I believe the seller has over valued the company a bit but that will be dealt with.

Chunk

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Re: How should I finance a business purchase?
« Reply #8 on: July 30, 2014, 11:47:36 AM »
Fair enough wizofloz. My brain is going straight to whether or not you should buy the business at all, but that clearly isn't what you're asking in this thread. Good luck to you. It sounds like you are a good fit for that business.

Mister Fancypants

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Re: How should I finance a business purchase?
« Reply #9 on: July 30, 2014, 12:03:36 PM »
I wouldn't put my house up as collateral....

Do option 2, cheaper rates anyway and tax deductible.

I know the business credit seems like a good thing but you also said the business is established so the business itself might already have credit history even if you don't have history with it.

If you just do the refi and have to sell the business in a pinch at least the houses are not at any risk.

Don't ever think they can't be at risk if you put them as a collateral they are at risk... Never risk your home like that.

Good luck!

wizofloz

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Re: How should I finance a business purchase?
« Reply #10 on: July 30, 2014, 12:36:03 PM »
The main reason I am shying away from option 1 is it seems like the bank is picking option 2, tacking on a bit of interest and some fees, then renaming it option 1. Either way I'm tapping the equity in the houses. From what Cpa Cat has said, if done right, I might as well become the bank and pay the fees and interest to myself. I feel like I would give myself a good deal.

Gone Fishing

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Re: How should I finance a business purchase?
« Reply #11 on: July 30, 2014, 12:42:55 PM »
Is the owner willing to offer financing?

wizofloz

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Re: How should I finance a business purchase?
« Reply #12 on: July 30, 2014, 12:49:20 PM »
The owner is willing to offer 'gap' financing. Meaning if other sources can't provide enough he will finance a small portion. He is well into his retirement years and has no desire to fund a 10 year loan.