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How to Buy a Profitable Business: What to Look for, and When to Run (From the People Who Know!)

If you’re looking to fund your business acquisition with an SBA loan, you need to start by convincing your lender that the business will be worth the risk. It’s up to you to make sure the business you’re purchasing makes the cut.

So what are SBA lenders looking for? And what are the things that send them running? Take a look:

Six things SBA lenders look for in your business

The SBA has published a list of items borrowers should look for when thinking about buying an existing business. While eventually you’ll want to do more due diligence on the business, these are the surface-level things to consider when vetting businesses for sale.

Price. Your SBA lender wants to make sure your business matches the buying price. Sometimes, if the price seems too good to be true, it is.

Proven concept. Does the business have a proven track record? For how long? Have there been any major setbacks that you are aware of?

Brand. You’ll be buying an established brand. What marketing and networking has already been established, and what is this brand’s reputation?

Reviews. How has this business been received in the community? This will tell you a lot about their reputation, and the worth of intangible assets like goodwill. Checking the reviews also alerts you to potential problems you could face with the business. Do they have a history of being slow with their payments? Or are there negative customer service reviews? If you’re keeping a lot of the staff with the acquisition, these are problems you’ll need to iron out once you take over.

Existing physical assets. Is there a functioning office space? What updates or upgrades would be necessary if you purchased the company?

Employees. What is the staffing situation? Will you have enough leadership transitioning with you to help the acquisition go smoothly?

In addition to examining your business, your SBA lender is also going to look at you. How do you fit in with this new acquisition? They might consider:

Interest and talent. Your SBA lender is going to look at you and your resume to see what interests and skills you have that are relevant to the business you’re purchasing. If you don’t have a proper understanding of the field, you may struggle to accurately assess available products, expansion opportunities, and market demand. And your business will struggle, too. If you’re lacking experience in the field of your potential business, you’ll need to take some additional steps to win your lender’s confidence and get your loan approved. Be prepared to supplement your weak spots with managerial experience in other industries, education and formal training in areas like sales or business, and a solid, air-tight business plan.

Sustainability. Another way to think about this is “quality of life.” Look at the previous owner. Did he or she have to commute, work extra on weekends or evenings, or travel frequently? While these aren’t bad things, if the work needed to keep the business running is unsustainable, chances are higher that the new owner will fall behind in the transition. Take some time think about how you’ll address this with your lender when they ask you about your time commitment to this new business.

If the business you’re purchasing is able to hold up to the initial lender survey, you’ve got your foot in the door for an SBA loan approval. But you aren’t there yet. Your lender also wants to see that there aren’t any red flags with the company that would suggest your purchase would be an unwise one.

When SBA lenders run

There are definitely things lenders don’t want to see when they look at the business you’re proposing to buy. Check for these things before you apply, saving yourself the embarrassment of being rejected for an SBA loan because you didn’t check to see if the business might qualify first.

While each case will vary by business and industry, there are definitely some general things to stay clear of:

Shifty bookkeeping. Be wary of businesses that overstate their profits, or claim to have profits that are “off the books.” Your SBA lender is going to look at what’s on the tax returns and financial statements to make the approval decision, so what’s on these documents needs to be accurate.

Old equipment. Is the equipment old or outdated? If the company’s equipment is going to get in the way of productivity, or be too outdated to sell in case of default, this could be a red flag for your lender. Consider using the old equipment as leverage to lower the asking price and reduce the loan amount that would be needed.

Recent changes in demographic or industry. Are there a lot of business owners in the area looking to sell? If the city is building a new shopping strip that’s diverting regular customers from the area, or a competing chainstore is scheduled to be built nearby, this isn’t where you want to place your business.

On that note, lenders will also look at changes in the industry itself before making a decision. Think about it. Fifteen years ago, a video rental store was a profitable, booming business. Within years, they were all forced out of business. Those who had the foresight to sell before the shift came out on top; those who decided to buy from them did not. Your SBA lender will look for industry trends to help determine whether your purchase is likely to be profitable in the long run.

Declining owner discretionary income. The owner discretionary income (ODI) is the amount the seller takes home after paying all supplier, rent, employee, and tax liabilities. If the ODI has been declining, be careful. A dropping ODI can be one of the first indicators to you and your lender that the business is going downhill.

Large turnover. High turnover rates in ownership signal to lenders that there’s something wrong with the company. If the business is changing hands every few years or more, chances are there’s a reason the sellers are anxious to be rid of it!

Ultimately, when it comes to deciding to buy, ask yourself: why is this business for sale in the first place?

If there doesn’t seem to be a reason to sell—like the owner retiring—there might be something going on the seller is hiding. But once you’ve ruled out the immediate red flags, you’re ready to start taking a closer look at the details of the company and proceed to buy.

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