Fundraising

Have you recently considered buying a business to make your startup easier to fund?

Nancy Fulton

July 31st, 2016

If so, I'd like to hear about your thoughts and experiences. Did you contemplate using an SBA loan? Did you approach the business you want to buy directly? Or did you try to use a broker or a brokerage site to find a business? Did the broker offer to help facilitate the financial transaction or were you planning to work with some other startup funding company... 
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Nancy Fulton

July 31st, 2016

Shobhit . . .

So if you want to buy a home in most places in the US, it's oddly easier to get a loan to purchase an apartment building than it is to get a loan to purchase a free standing house, even though the apartment building costs a great deal more.

Because the bank looks at the transaction and says "rents will be paying for the purchase". So they look at the value of the property, the rents its already earning, etc. So in effect the buyer is only part of the equations. If the property will cost 2M, and the rents cover 1.5M, the owner is really responsible for .5M. Where as if they were purchasing a 1M house or a 2M house (no rents) the bank would laugh outloud.

So a startup business owner who buys a business simply has to find a business that is earning enough money to cover the cost of the loan, running the business, and their salary (which is usually a cost the business is already paying to the current owner).

Ex: If I want to start an app that sells car repair services (kind of like uber for car repair shops), I might be better off purchasing a car repair shop . . . and then treating app development as a marketing expense . . .

Because I can get probably get $1M-$2.5M funding directly from the SBA for the car repair shop if its got a good customer base, and good staff, and owns its own lot. It probably is paying it's owner $5K-$10K a month, and it probably has an advertising budget of $5K-$10K I can put into an app.

From an investor perspective, after the sale, I can see . . . 1) this company has customers 2) it has assets 3) it has a business it can use to test it's app . . .

In effect the app company has bootstrapped its business with an SBA loan.

To purchase that business, founders don't need a lot of cash up front, and if they do need cash they can go to the same investors they are currently approaching to say "look, do you want to invest $100K-$200K in a business that already has revenues, that already has property, and will be developing this app". From their point of view, this is now a very non-risky venture. They just have to trust you not to tank the car repair business . . . which was running well enough the SBA would give you a loan when you bought it.

In effect the SBA has rubber stamped you and provided 2.5M in funding so you can execute this plan.

And the SBA is totally fine with you improving an existing business. A tech that buys a car repair place is clearly going to leverage their technical skill to create a marketing advantage. They'll use that advantage to expand revenues . . .

Irwin Stein Very experienced (40 years) corporate,securities and real estate attorney.

July 31st, 2016

Nancy:  I did not read your question to suggest that you were either a business or loan broker. I have worked with both over the years.  You are correct that many people never consider an SBA loan. Many of the entrepreneurs on FD are younger and the SBA wants collateral, usually the family home.  Buying a competitor to strengthen your own balance sheet is, frankly, beyond what a lot of people on the site can handle. If you are buying the company with debt, and can quickly convert it to equity, the strategy makes some sense. If this is something that you are considering and want to speak to an old pro to hash it out, feel free to contact me.

Shobhit Verma

July 31st, 2016

Nancy,
There is something mathematically wrong with what I am understanding from your question.
If the entrepreneur had means to finance buying a business, wouldn't they have the same means to fund their own startup ?
How can the entrepreneur buy a business which owns a property without financing that amount ?

I am assuming there is something I am missing, can you please give an example with cashflows and asset assumptions ?

Willi Melkov Businessman, Sales Expert and Growth Addict

July 31st, 2016

I bought a business to enter a niche, not to fund another startup though. Usually you don't need a brokerage. 

To fund your startup it would make sense to acquire a complimentary company (complimentary to your startup idea). This way you can use its cash flow to finance your r&D costs in addition to having customers ready once your product is finished. 

For funding I'd recommend loans (in case it's a company with strong assets) in combination with equity capital to acquire expertise from angels and vcs. 

Nancy Fulton

July 31st, 2016

Exactly.  A startup can purchase a company in the target industry, that already has customers, revenues, and assets . . . Founders get a salary, and they can fund deployment of new products.  I'm working with a company that does SBA loans with no upfront costs, and with only the approved SBA fees paid during closing. . . they work with some business brokers . . . but I think startups are a good target market because they'll get launched faster, give up little or no equity, acquire revenues, and be more attractive to investors faster. So I want to know where like-minded startups have been looking for businesses to buy.  Did they go direct to the business, or to brokers? 

Nancy Fulton

July 31st, 2016

That wasn't my intent . . . How do you ask about business issues without talking about business issues.  It's a site for business people by business people.  

I'm specifically saying most people don't know they can use an SBA to launch or grow their business.  That's the specific topic I'm addressing. I'm asking this forum if they have considered doing that, and if so whether they used a broker or approached the business owner directly. 

I think it's a pretty normal question. 

Nancy Fulton

July 31st, 2016

Thank you Irwin.  I really didn't want to alienate anyone . . . I just figured folks on this site, taken as a whole, had tried every funding, business purchase, or business sale option known to man . . . 

I've worked with people who brought investors in (15% each) to fund the down payment required for the loan. The purchaser did have to provide the personal guarantee which is a non-trivial obligation.  In one case the buyer had a FICO of 650 and I'm not sure they even owned a house. The SBA was evaluating the business they were buying, that business's revenues, their professional background, and their plan for the business in making the loan, rather than the business owner's assets . . . since it was a multi-million dollar purpose the assets of the new owner were never going to provide any real security for the loan.

If an entrepreneur/startup purchases a business that owns property (for example it's own premises) that provides more security for the loan (and gives the owner 25 years to repay the loan). 

I'm supporting a company that provides business services, among them help purchasing or selling a company with financing provided by the SBA. They will step in to negotiate the deal, or just process the loan. So I'm not asking for a solution for funding my own startup . . . I'm asking if founders who have considered SBA loans approached the business directly or worked with a broker.  Because from a marketing standpoint, if they all use brokers, I have to market to brokers . . . 

Irwin Stein Very experienced (40 years) corporate,securities and real estate attorney.

July 31st, 2016

Nancy Thinking back, most of the transactions have been through a broker or other intermediary. Most of the companies being sold were by founders who were retiring. I was recently contacted by a business broker who wants to crowdfund the down payment for the SBA loans. I am in the process of helping him to set up his own crowdfunding platform. If that is of interest to you, I can show you how it can be done.

Nancy Fulton

July 31st, 2016

Irwin . . . the company I'm working for to date has worked with investors and with the seller to handle down payments. But I'll let them know you're available to chat with them about the crowdfunding angle.  Mostly they get deals done in 90-100 days from first contact, and I don't know if crowdfunding will work fast enough to fit into that model. 

Shobhit Verma

July 31st, 2016

Nancy,
Thanks for sharing the example! It is very well written.
I can see that this could work for some businesses.
However disciplined VC investors want to see the founders to be very focused. This usually means that there is one cofounder completely focused on technology and one cofounder focused on sales. Running a services business is usually not-so-passive activity and takes away attention from the founders.

That said, if the product is really phenomenal, the VC can always invest and ask them to sell the service business.

However, most startups will never see an investment from the VC, so I can see that this is a good way to bootstrap!

I have an educational app and I was myself thinking of buying a tutoring center and bootstrap instead of raising money. Finding a tutoring center which is for sale and also owns the asset will be really hard! But I can see how it could work out if a business like that existed.

Regards,
Shobhit