Can You Buy a Business if You Have Bad Credit?

The short answer: It depends. Having bad credit makes the process of buying a business more difficult. It will require more work. It will require persistence. However, getting a business acquisition loan while having bad credit is not always impossible. In this article, you will learn:

  1. What exactly bad credit is
  2. Why your credit is important
  3. How to manage your application if your credit is bad
  4. Financing alternatives

The basics. Let’s define “bad credit”

Credit is measure of trust. Credit measures how much a lender trusts you with its money. It is measured by looking at a number of variables and converting them to a number. This number is called the FICO score.

The higher the FICO score, the greater the chance that you will repay the lender in full – and on time. On the other hand, lower scores suggest a lesser chance of timely payment.

Each institution defines “bad credit” in its own way. However, Experian uses these numbers:

  • Exceptional: 800 – 850
  • Very good: 740 – 799
  • Good: 670 – 739
  • Fair: 580 – 669
  • Very poor: 300 – 579

When it comes to getting a loan to purchase a business, your personal credit matters.

Why is your personal credit important?

You may be asking yourself, “Why is my personal credit important? I’m asking for funds to purchase a business. Isn’t this supposed to be business credit?” This is a common question.

The answer is simple. Businesses don’t manage and operate by themselves. They are managed by people. More importantly: small businesses are often managed by the people who bought them.

Since credit is a measure of how that person manages their personal life. Lenders assume that how you manage your personal life is a strong indication of how you will manage your business. It may not be a perfect measure, but lenders rely on it.

What are lenders looking for?

The bottom line is simple. Lenders are looking to make a good loan. To them, a loan is an investment. They want to make sure that their money is safe – that they will be paid back on time and with interest. It’s that simple.

With that in mind, your job is simple. You must present a solid business case so that the lender views you as a low risk. Frankly, few people do this. Even those with good credit. You can use this to your advantage. This is how you can differentiate yourself and increase your odds of winning.

A word of caution

Getting a loan to purchase a business is an uphill battle for everyone, regardless of credit. There are no guarantees of success. Frankly, even good credit does not guarantee success. You need to accept this fact.

However, there are options. It all starts with doing your homework before you contact the lenders.

Present a solid business case

One of the biggest mistakes that hopeful entrepreneurs make is being sloppy. We often get contacted by individuals who have not done their due diligence. They contact us to find out how much financing they can get. However, they cannot show us:

  1. An executive summary of the opportunity
  2. Simple financials
  3. Industry experience

Don’t approach a finance company without basic knowledge of the business you plan to purchase. It makes you look bad. And if you have bad credit, it makes you look worse. It makes you look like you don’t know what you are doing.

Perform some due diligence on the business before you contact the lenders. Make sure this is a business you want to buy and are ready to make an offer.

Your executive summary should be simple and to the point. It should describe the important aspects of the business and why it’s a good match for you. You should also provide basic financial statements.

There is one more step. Before speaking with finance companies, you need to do one more thing.

Why is your credit bad?

Sooner or later, the finance company will check your credit and find out it’s not good. Once they ask about it, you should have a good explanation.

The fact is that there are many reasons why a person may have bad credit. They may have gone through a:

  1. Divorce
  2. Illness
  3. Job loss
  4. Major life event

If this is the case, there is a chance that many lenders will understand your situation. If you are asked, it helps if you present your situation well. Write a professional-looking statement explaining:

  1. What caused the problem
  2. How you tried to solve it
  3. Efforts made to pay debt back
  4. Why this is no longer a risk

There is one situation left. What if your bad credit is due to earlier bad decisions? That’s a tough one. Well, that happens to some people. Unfortunately, it makes the situation much harder. You are usually better off admitting it though. Honesty is always the better path. However, your statement should include a section of how things have changed. Specifically, what actions you are taking to ensure this does not happen again.

Bad credit business acquisition options

The following are some business acquisition financing alternatives that can work for individuals with bad credit or who can’t put much money as down payment.

1. Friends and Family

Asking friends and family to invest in a business with you is a risky option. I don’t recommend it. However, this option can work for some folks. If you choose this route, consider these suggestions:

  1. Be direct and honest
  2. Create a good presentation
  3. Treat family and friends as you would treat professional investors
  4. Have a lawyer review important documents
  5. Honor your commitments
  6. Give them a chance to say NO

Also, ask only individuals who can contribute something more than just money. They should also contribute experience or industry contacts.

2. Seller financing

Most small business acquisition transactions include a seller financing component. This type of financing allows you to bypass institutions.

Basically, you create a loan note between yourself and the seller. You then pay the seller accordingly.

It’s unusual for a seller to provide 100% financing. Most of the time they finance only a portion of the sale. The rest of the funds have to come from elsewhere.

3. SBA Microloans

The Small Business Administration (SBA) has a great program called the micro-loan program. Depending in your state of residence, they can provide up to $50,000 of financing. The financing comes from partners (the SBA does not lend directly) who also provide business counseling. Get more information at the SBA’s site.

4. Business acquisition loans

Most business acquisition loans are backed by the SBA. They are an excellent program for individuals looking to buy a business.

As said before, the SBA does not offer loans. Rather, it provides guarantees to lending institutions. These institutions offer the loans to the individual.

Each lending institution has its own loan requirements. As a rule, your credit score should be at least 650. Some institutions can work with lower scores. Do your due diligence. You may need to speak to a number of institutions before you find one that will work with your score.

5. Leveraged buyouts (LBOs)

Lastly, you can purchase a company through a small business leveraged buyout. Most small business leveraged buyouts use a combination of funding methods.

The idea of an LBO is to buy a business with as much leverage as possible. Leverage is another term for borrowed capital.

Leveraged buyouts allow you to maximize your return on equity. This can be great if things go well. However, if things don’t go well, LBOs can also maximize your losses. Use this technique carefully.

Often, LBO transactions require a down payment as well. However, some transactions have been done with no down payment. These are very hard to find and close. Basically, you must find a business that is willing to sell for a cost that is lower than those of its assets.

Editor’s note: This article is provided for information purposes only. It does not provide legal or financial advice. If you need advice, consult an expert.