How to finance buying a business
Three sources of money, one number that decides whether you get any of it, and a worked example on a real-sized deal. Read this before you make an offer.
Most first-time buyers approach financing backwards. They find a business they like, agree a price, and then ask a lender whether it works. Lenders answer that question with a single ratio, and by the time you hear the answer you have already spent weeks and possibly money on a deal that was never fundable at that price.
This guide runs the other direction. Understand how the money is structured, understand the ratio, and you can screen a listing in a few minutes before you ever call the seller.
The three sources of money
Nearly every small-business acquisition under about $5M is funded from the same three places, in roughly this order of size.
1. An SBA 7(a) loan — usually 70% to 80%
The Small Business Administration guarantees a large share of the loan, which is why a bank will lend against a business's cash flow rather than hard assets. Terms are typically ten years for a business purchase, at a rate a few points above prime. The loan can also cover working capital and closing costs, and the guarantee fee — a few percent of the loan — is normally rolled in rather than paid up front.
The lender's job is to confirm the business can repay the loan from its own earnings, after paying you a salary. That test is the whole game, and it has a name: debt-service coverage. For the full mechanics of the program — the equity rule, how seller notes count, the fee, the timeline — see using an SBA loan to buy a business.
2. Your equity injection — 10% to 20%
SBA rules require the buyer to put real money at risk. The floor is 10% of total project cost, and many lenders want more from a first-time buyer. This is cash from your own resources: savings, a retirement rollover, a home equity line, or a gift with a letter behind it.
Two things trip people up here. First, "project cost" includes working capital and closing costs, not just the purchase price, so 10% of a $1.2M business is usually more than $120,000. Second, part of the injection can sometimes be satisfied by a seller note — but only if that note is on full standby, meaning the seller receives nothing until the SBA loan is repaid. Confirm the current rule with your lender before counting on it.
3. A seller note — 0% to 20%
The seller lends you part of the price and you repay it over several years, typically at a modest rate. It closes the gap between what the lender will fund and what you can bring, and it keeps the seller motivated to help the business transition well, because they are paid from its future earnings.
Sellers often resist a note in the first conversation and accept one in the third. The trigger is usually a lender's coverage test coming back short at the asking price. At that point the seller's choice is a note, a lower price, or a longer wait for another buyer, and the note is frequently the least painful of the three.
The number that decides everything: debt-service coverage
Every SBA lender asks the same question first. After the buyer takes a reasonable salary, does the business generate enough cash to cover the loan payments with room to spare?
The ratio is cash available for debt divided by annual debt service. Lenders generally want 1.25x or better on the business's historical earnings. That means the business produces a quarter more cash than the loan needs. Below about 1.15x, most will decline, or ask for a larger down payment, a seller note, or a lower price.
The part buyers miss: "cash available" is not the seller's discretionary earnings figure from the listing. It is SDE minus the salary you need to live on. A listing showing $412,000 of SDE is showing you what the current owner took out. If you need $95,000 a year, the lender sees $317,000. Every deal should be screened on the second number, not the first.
A worked example
A service business is listed at $1,200,000 with $412,000 of SDE. You need $95,000 in salary, you can put 10% down, and the seller will carry 10%.
| Item | |
|---|---|
| Asking price | $1,200,000 |
| Your equity, 10% | $120,000 |
| Seller note, 10% | $120,000 |
| SBA loan, 80% plus 3% guarantee fee | $988,800 |
| Annual SBA payment, 10 years at 10.5% | ~$160,000 |
| Annual seller note payment, 5 years at 7% | ~$28,500 |
| Total annual debt service | ~$188,500 |
| SDE minus your salary | $317,000 |
| Debt-service coverage | 1.68x |
That deal works at asking. Coverage clears 1.25x comfortably and you keep roughly $128,000 a year after salary and debt. Now change one input: suppose the real SDE, after you strip out add-backs the seller overstated, is $310,000. Cash available drops to $215,000, coverage drops to 1.14x, and the same deal no longer funds at $1.2M. The maximum price a lender will support falls to roughly $1,075,000 — and that is before working capital, which pushes the number lower still.
That swing — over $120,000 off the price — came from one earnings adjustment. It is why the coverage ratio is worth understanding before you fall in love with a listing.
Run this on any listing in thirty seconds
The free deal analyzer takes the asking price, the SDE, your salary need, and your financing mix, and returns the multiple, the SBA payment, the coverage ratio, and the maximum price the deal supports. No email required.
Open the deal analyzer →What lenders look at after the ratio
Coverage gets you a conversation. Four other things get you a closing.
The add-backs. SDE is net income plus the owner's compensation, benefits, one-time items, and anything personal run through the business. Sellers and their brokers are motivated to find every add-back. Underwriters are motivated to reject the weak ones. Owner's salary and interest are always accepted; "one-time" expenses that appear every year, family members on payroll who actually work, and personal vehicles that are also delivery vehicles are where deals get repriced.
Your experience. Lenders want a buyer who can run this specific business. Industry experience helps, general management experience helps, and a transition period with the seller staying on helps most of all.
Working capital. You will need cash in the business on day one for payroll, inventory, and receivables that have not collected yet. It is part of project cost, it is fundable, and forgetting it is the most common reason a buyer's cash-to-close comes out higher than the down payment they planned for.
Collateral. SBA loans are cash-flow loans, but lenders still take what collateral exists: business assets, and often a lien on personal real estate. Understand what you are pledging before you sign.
Structures that reduce cash to close
If the numbers are close, three levers move them.
A larger seller note. Each dollar the seller carries is a dollar you do not borrow from the bank or bring yourself. Sellers accept larger notes when the alternative is a lower price.
Earn-outs. Part of the price is paid only if the business hits agreed targets after closing. Useful when the seller believes in growth the historical numbers do not show. Lenders treat earn-out payments cautiously, so structure them with your lender in the room.
Real estate separated from the business. If the seller owns the building, buying the business and leasing the property is a smaller loan with a longer runway. Many buyers acquire the real estate later, once the business has proved itself.
What a no-money-down deal usually is
Occasionally a structure combines a heavy seller note, a small SBA loan and a standby arrangement to get cash-to-close near zero. It happens. It is rare, it requires a seller who is unusually motivated and unusually trusting, and it almost never clears a lender's equity requirement without something at risk from the buyer.
If someone is teaching you to buy businesses with no money down, they are selling the teaching. Screen every deal on coverage, bring real equity, and use a seller note to close the gap. That is how acquisitions actually get financed.
Questions buyers ask
How much money do you need down to buy a business?
With an SBA 7(a) loan, expect a 10% equity injection at minimum, and 15% or more if you are a first-time buyer. That is calculated on total project cost, which includes working capital and closing costs. On a $1.2M purchase, plan for $120,000 to $180,000 in cash.
What coverage ratio do SBA lenders require?
Most look for at least 1.25x on historical earnings after a reasonable buyer salary. Below about 1.15x the deal generally does not fund at the asking price.
Does a seller note count as my equity?
Sometimes, and only partly. It has to be on full standby for the life of the SBA loan, and current rules cap how much of the injection it can represent. Confirm with your lender before you rely on it.
Can you buy a business with no money down?
Rarely, and almost never through an SBA lender. Structures exist that reduce cash to close substantially, but lenders require the buyer to have real capital at risk.
Buying to grow, not just to own?
XP M&A Advisory works with established owners acquiring their way to five to seven times their current size. If you are past the first deal and thinking about the next three, that is the conversation we have.
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