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Starting a general contractor business can be a rewarding venture, providing the opportunity to showcase your skills while helping others achieve their construction and renovation dreams. Whether you're a seasoned professional in the construction arena or a committed entrepreneur interested in the industry, this guide is for you. 

We'll walk you through the necessary steps, ensuring you understand the ins and outs of launching your own general contractor business. Let's embark on this exciting journey together.

1. Develop your business plan.

Just like any worthy endeavor, your general contractor business needs a plan. In its simplest form, this document will outline what your business is going to do and how you’re going to do it.

So what goes in your plan? The best way to think of it is as a collection of answers. In the process of answering important questions about your future business, you’ll develop the framework that will guide your business into the future.

Possible questions to prime the pump include:

• What will your main objectives be?
• What are your key strategies?
• What will your mission statement be?
• How will you market your business?
• How will you stand out from the competition?
• What are your projections for your business?

To thoroughly answer these questions, you’ll need to conduct an industry analysis and additional research. These actions are time-intensive but will provide essential data and spur ideas.

2. Decide on the structure of your business.

When you’re ready for your business to really take shape, it’s time to figure out the name and structure. First, research potential names that would resonate with customers and help you stand out from the competition. Then peruse construction industry directories to make sure the name isn’t already in use. You’ll also want to make sure the domain name is available. Finally, go to the U.S. Patent and Trademark Office’s website to make sure your preferred name is yours for the taking.

At this point, you need to choose a legal structure for your business. There’s no silver bullet here, as each structure has pros and cons. Due to the importance of this element of your business setup, this is an excellent topic to discuss with your mentor.

So what are your options when it comes to business structures? Here’s a breakdown of the five most popular:

1. Sole proprietorships - This route is the easiest. A sole proprietorship is designed for just one owner, meaning every aspect is streamlined. As the single owner, you assume complete responsibility for the business. The profits flow straight to you, but so will any losses. Sole proprietorships do not provide liability protection, meaning your personal assets could be at risk. 
2. Corporations - If there will be multiple owners of your business and liability protection is a priority, you should consider a corporation. With this structure, your business is considered its own legal entity. In the unfortunate case of severe debts and losses, your assets would be shielded. Just know that it’s a fairly complex process to set up corporations, and the costs are higher than with a sole proprietorship.
3. General partnerships - This structure is ideal if there will be more than one owner and everyone wants an equal stake in the company. Each partner will have a voice when it comes to decisions in a general partnership, but the downside is they all share liability for the finances as well.
4. Limited partnerships - If there is a hierarchy among your potential partners, you should consider a limited partnership. The unique structure allows some individuals to be dubbed full partners, while others can assume more of an investor relationship with the business. Full partners will shoulder the liability, while the secondary partners are protected.
5. S corporations - This hybrid structure combines the liability protection of corporations with some of the financial convenience of sole proprietorships. But that’s not to say that S corporations are easy to create and run. You’ll have to meet certain requirements, such as conducting meetings for shareholders, recording the minutes, and soliciting shareholder votes on decisions.
6. Limited liability companies (LLCs) - This common structure is chosen by small business owners due to its user-friendly benefits. For example, an LLC provides liability protection and has lenient tax rules, while also allowing for as many shareholders as you wish.

3. Register for an EIN and create a bank account.

You could have the best business plan in America, but you still probably wouldn’t be able to do business without an Employee Identification Number (EIN). Go to the application page on IRS.gov and you’ll be pleasantly surprised by how easy it is to register your business.

Next, you’ll need to take care of a bank account. The most convenient route is to open a business account at the bank where you already handle your personal finances. Because the bank has your personal data and has established a track record with you, the application process will be much faster.

4. Obtain necessary licenses and permits.

As a general contractor, you're required to have specific licenses and permits to legally operate your business. The requirements vary depending on your state, so it's crucial to research what's needed in your particular location. Typically, a general contractor license, business license, and building permits are a must-have.

To get your general contractor license, you'll likely need to pass an examination that tests your knowledge of the construction industry and business practices. This license permits you to legally perform and oversee construction projects. Check out the National Association of State Contractors Licensing Agencies for more detailed information on each state's requirements.

A business license—obtained through your local city or county government—authorizes you to operate a business within their jurisdiction. You may also need to apply for specific permits depending on the nature of the projects you undertake, like electrical, plumbing, or demolition permits.

Remember, it’s not enough to just have these licenses and permits—you must also ensure they are always up to date. Operating without the necessary licenses or permits (or with expired ones) can lead to hefty fines and potentially damage your business reputation. Keeping on top of these administrative tasks can help ensure the long-term success of your general contractor business.

5. Secure the right insurance.

Just as important as obtaining the necessary licenses and permits for your general contractor business is securing the appropriate insurance. When operating a general contractor business, several types of insurance are considered industry standards. These include:

1. General liability insurance - This type of insurance provides coverage for any accidents or injuries that occur on the worksite. It typically covers medical expenses, legal fees, and any damages awarded in a lawsuit.
2. Workers compensation insurance: - If your business has employees, most states require you to carry workers' compensation insurance. This coverage provides wage replacement and medical benefits to employees who are injured on the job.
3. Commercial auto insurance - If your business owns vehicles, commercial auto insurance is a must. This insurance protects your company from the financial fallout of an auto accident, including coverages for property damage, medical expenses, and liabilities.
4. Builders' risk insurance - This type of insurance covers a construction project from various risks such as fire, theft, or natural disasters while the project is underway.
5. Professional liability insurance - Also known as errors and omissions (E&O) insurance, this covers you if a client claims that errors or negligence in your work caused them financial harm.

Remember, the specific insurance requirements may vary depending on the location and nature of your projects. It's crucial to work with an insurance expert or broker to identify the right coverage for your business needs. Operating without the right insurance can expose your business to unnecessary risks and potential financial hardship.

6. Understand the importance of contractor bonds.

In addition to securing the right insurance coverage, another crucial aspect to consider when starting a general contractor business is obtaining contractor bonds. Contractor bonds, often required by law, provide a financial guarantee that you will fulfill your contractual obligations to your clients.

There are different types of contractor bonds, but the most common ones are:

• Bid bonds - These assure the client that you will honor the terms outlined in your bid if it is accepted.
• Performance bonds - These provide a guarantee that you will complete the project as per the terms of the contract. In case of default, the client is compensated up to the full amount of the bond.
• Payment bonds - These ensure that all subcontractors, laborers, and material suppliers involved in the project will be paid.

Obtaining a contractor bond involves applying through a surety company or a bond broker. They will evaluate your financial health, industry experience, and creditworthiness before issuing a bond. Keep in mind that you may be required to pay a premium, usually a percentage of the bond's total amount.

Remember, having contractor bonds not only fulfills legal requirements but also enhances your credibility with clients by demonstrating your commitment to completing projects as promised. It's always a good business practice to stay bonded to protect your business, your clients, and your reputation in the industry.

7. Finance your business.

One of the most important elements of your business plan is deciding how much money you will need and when you’ll need to acquire it. There are diverse expenses related to getting a construction business up and running, including materials, equipment, vehicles, trailers, tools, insurance, licenses, office furniture, computers, and software.

You’ll also need to consider less obvious expenses, such as advertising, maintenance, payroll, and professional fees. Many entrepreneurs struggle with their budgeting because they don’t account for all of these ancillary aspects.

When you know exactly how much money you need, you’ll be in a prime position to seek any necessary financing. Here are five common types of financing for general contractors:

1. Term loan - A term loan is a lump sum of capital you pay back over a fixed period. The payments are made monthly, and the interest rate can be either fixed or variable.
2. Invoice factoring - As a general contractor, you may find that some clients don't pay their invoices promptly, which can create cash flow problems. Invoice factoring is a financial solution where a third-party company, called a factor, buys your unpaid invoices for a fee. You get the cash immediately, allowing you to finance ongoing operations, while the factor collects the invoice payment when due. This option can be highly beneficial if your construction business operates on a B2B model.
3. Equipment financing - This type of financing involves borrowing money to purchase equipment and other assets. The asset serves as collateral for the loan, often leading to lower interest rates.
4. Business credit card - Most entrepreneurs get business credit cards so they can begin separating their business purchases from their personal expenses. They function just like any other credit card.
5. Line of credit - This financing product is similar to a credit card because it gives you ongoing access to a set amount of money. The benefit here is that you can spend cash only when you need it and keep it as a safety net when you don’t, rather than always needing to pay interest on a lump sum.

Regardless of which route you take for your financing needs, it’s advisable that you get an accountant to help manage your money from here on out. Not only will an accountant keep your finances accurate and secure, but they can also help you spot potential problems and find remedies before it’s too late.

8. Hire subcontractors.

Hiring subcontractors is a crucial part of running a successful general contractor business. As a general contractor, you'll often rely on subcontractors to complete specific parts of a project that require specialized skills. Here's how to go about it:

1. Identify your needs - First, determine which tasks or projects require subcontracting. This could be anything from electrical work and plumbing to roofing and flooring. Understand the scope of the project and the skills needed to complete it successfully.
2. Search for subcontractors - Once you've identified your needs, start looking for suitable subcontractors. You can leverage online construction networks, trade associations, or local business directories. Word-of-mouth referrals from other contractors, suppliers, or previous clients can also be helpful.
3. Evaluate potential subcontractors - After identifying potential subcontractors, assess their skills, experience, reliability, and reputation. Check their references, previous work, and online reviews. Also, ensure they hold the necessary licenses, insurances, and bonds.
4. Negotiate terms - Once you've chosen a subcontractor, negotiate the terms of the contract, including the scope of work, deadlines, payment terms, and responsibilities of each party. Be sure to put everything in writing to avoid future disputes.
5. Manage and communicate - Maintain regular communication with your subcontractors once the work begins. Clear, regular communication helps to ensure everyone is on the same page regarding project expectations and deadlines.

Remember, hiring the right subcontractors can greatly affect the quality of your work and your reputation as a general contractor. Take your time to select subcontractors who are experienced, reliable, and professional. After all, the success of your general contractor business depends heavily on the team you build.

9. Seek out a trusted mentor.

Every entrepreneur can benefit from the guidance of a mentor, but it’s especially helpful for those in the construction industry. Whether this guru is actively working or has retired, it’ll be essential to draw from the experiences and problem-solving abilities of someone who has already built a business from the ground up.

If you have a difficult time finding a potential mentor, don’t be afraid to venture outside of your immediate sphere of contacts. Start by checking out the free resources available from your local SCORE chapter or SBA Small Business Development Center.

It won’t matter if your mentor is a close friend or a stranger. The important thing is that you’ll have a support system and sounding board in place. The construction industry can be a rocky road, so stay close to those who know how to best navigate it.

You can also make powerful relationships by joining an industry association. Two great choices are Associated General Contractors and Associated Builders and Contractors. Use these networking opportunities to get answers to your questions big and small.

10. Deploy effective marketing strategies.

In today's competitive business environment, marketing your general contractor business effectively is more important than ever. A well-structured marketing strategy can help increase your visibility, attract new clients, and ultimately grow your business. Here's how you can go about it:

1. Establish a strong online presence - In the digital age, an online presence is vital. Start by creating a professional website showcasing your services, past projects, client testimonials, and contact information. Maintain an active presence on relevant social media platforms where you can engage with potential clients and share updates about your work.
2. SEO and local listings - Optimize your website for search engines (SEO) to make it easier for potential clients to find you. List your business on local directories and Google My Business, ensuring your contact information is accurate and consistent across all platforms.
3. Network - Attend industry events, join local business networks, and build relationships with other professionals in your field. Networking can often lead to referrals and new business opportunities.

Remember, marketing is an ongoing process, not a one-time event. Keep testing different strategies, track your results, and continuously adjust your marketing plan based on what’s working for your general contractor business. The key to effective marketing is consistent, authentic engagement with your audience.

11. Learn how to bid on construction jobs.

Estimating and bidding on construction jobs are essential skills for running a successful general contracting business. These processes allow you to competitively price your services, win contracts, and ensure your projects are profitable. Here's a brief walkthrough:

1. Understand the project scope - Before you can create an accurate estimate, you need to fully comprehend the project's requirements. This involves understanding the client's needs, reviewing blueprints, and identifying needed materials, labor, and equipment.
2. Calculate costs - Next, calculate your direct costs, such as labor, materials, and equipment rentals. Don't forget to also factor in indirect costs like overhead, permits, and insurance.
3. Add your profit margin - Once you've calculated the total costs, add in your desired profit margin. This will be the basis for your bid.
4. Prepare a bid - Your bid should be detailed, professional, and accurate. Be sure to include a breakdown of costs and a timeline for the project.
5. Submit your bid - Once you're happy with your bid, submit it to the client. Be prepared to negotiate and answer any questions the client may have about your bid.

Bidding on projects can be complex, but with practice and the right approach, you can create effective bids that win you more business. For a deeper dive into this process, check out this Beginner's Guide to Bidding on Construction Jobs. It provides a comprehensive look at the bidding process, from understanding the project to submitting your bid.

12. Stay the course, but stay limber.

There’s no doubt that your business plan will be crucial in the coming months and years. But it should remain a working document—never treat it like it’s written in concrete. The future holds many exciting opportunities for your business, as well as unexpected difficulties. Your ability to adapt and refine will be essential to your success.

By working hard and leveraging your network, you can help your general contractor business thrive. Entrepreneurship takes courage, so even on the toughest of days, hold your head high. You’re not just building a business. You’re building a legacy.

Despite labor and supply chain issues, the U.S. construction market is booming. In fact, analysts predict North American construction output to grow 32% by 2030. 

Construction business owners can capitalize on these opportunities while navigating challenges by having a smart financing plan in place. Using a line of credit for construction businesses, contractors, and builders creates a financial safety net at all times.

What is a construction line of credit?

A business line of credit helps construction-related industries maintain ongoing access to capital. It’s similar to a credit card in that you have access to a credit line and only pay interest on the amount of money you borrow. Once you repay your balance, you can continually borrow from the line of credit for the rest of its term.

Having a line of credit comes with a lot of benefits for construction-related businesses. It helps companies manage cash flow during periods of large expenses, including insurance premiums, licenses and permits, raw materials, and payroll.

Secured vs. unsecured lines of credit.

Secured and unsecured lines of credit constitute two primary categories of construction lines of credit.

A secured line of credit involves collateral, such as equipment or real estate, which the lender can claim if the borrower defaults on the loan. This type of credit is typically larger, with lower interest rates due to the reduced risk for the lender.

An unsecured line of credit doesn't require collateral. However, they usually come with higher interest rates and require a strong credit history for approval, due to the higher risk posed to the lender. These options cater to different needs, and the choice between a secured or unsecured line of credit should be based on the borrower's financial situation and risk tolerance.

Line of credit options for startups.

While it's generally harder for young companies to qualify for financing, some lenders will offer a line of credit to businesses with a minimum time in business of at least six months if you meet the other eligibility criteria. Learn more about specific lines of credit available to startups here.

Benefits of a construction line of credit.

Some of the benefits of a business line of credit include:

• Flexibility - Businesses don't have to draw on the entire credit line if they don't need it, unlike a traditional loan where the full amount is typically disbursed at once.
• Easy access to funds - Borrowers can access funds quickly and easily when needed, without having to reapply for a loan every time.
• Better cash flow management - A line of credit can help businesses stay afloat during lean times or when facing unexpected expenses.
• Lower interest rates - Compared to other types of financing options, lines of credit often have lower interest rates, which can save businesses money in the long run.
• Increased purchasing power - With a line of credit, businesses have more purchasing power and can take advantage of discounts.

Line of credit for contractors.

Contractors are especially susceptible to cash flow issues, especially while waiting on customers to pay invoices on time and purchasing materials to start a new job. And when managing larger projects with employees or subcontractors, there’s even more capital required to cover payroll costs.

To stay liquid, a line of credit for contractors helps even out inconsistent income. A line of credit can also help you grow your business by funding the upfront costs of new projects as demand for your services grows.

How can you use a construction line of credit?

A construction company can use a line of credit for a number of different purposes, such as:

• Purchasing equipment - When old equipment breaks down or new projects demand more specific machinery, a line of credit can be used to purchase or lease needed equipment. This can help avoid project delays and lost productivity.
• Buying materials - Construction projects require a lot of raw materials upfront. A line of credit allows for these materials to be purchased and costs managed until clients make their payments.
• Managing payroll - During periods of heavy work, construction companies may need to employ more workers. A line of credit can be used to cover these additional payroll costs.
• Expansion - When a company is looking to expand its operations—either by taking on more projects or increasing its physical footprint—a construction line of credit can provide the necessary funds.
• Emergency expenses - In construction, unexpected costs are a given. Whether it's damage that needs repairing, cost overruns, or abrupt changes in project scope, a line of credit can cover these unexpected expenses.
• Marketing and advertising - To attract new clients and bid on larger projects, construction companies often need to invest in marketing and advertising. A line of credit can be used to finance these efforts.

Requirements for a construction line of credit.

Lenders consider three primary factors when evaluating a construction industry line of credit. Here’s what they’ll look for:

• Time in business - Currently, most lenders want borrowing companies to have been in business for at least six months.
• Revenue - Lenders vary but most will be looking for construction businesses that can show gross revenue of at least $50,000 per year.
• Credit score - Currently, lenders in the Lendio network require a personal credit score of at least 600.

Business loans vs. line of credit

In the construction industry, understanding the distinct differences between traditional business loans and a line of credit can help determine which financing option is best suited for your individual business needs.

How to apply for a line of credit for your construction business.

Applying for a line of credit is similar to applying for any other type of financing. You'll need to provide standard business and personal information, along with some additional details specific to your construction industry, such as:

• Copies of contracts or purchase orders from current projects.
• A list of equipment you own or lease.
• Estimated budgets for upcoming projects.
• Financial statements and tax returns for your business.

Conclusion

A line of credit is an essential tool for construction businesses looking to manage cash flow, take advantage of opportunities, and navigate challenges in the ever-growing industry. By understanding the different types of lines of credit available, how to qualify for one, and how to use it effectively, construction companies can ensure they have set themselves up for strong growth.

*The information in this blog is for informational purposes. It should not be used as legal, business, tax, or financial advice. The information contained in this page is Lendio’s opinion based on Lendio’s research, methodology, evaluation, and other factors. The information provided is accurate at the time of the initial publishing of the page (November 13, 2023). While Lendio strives to maintain this information to ensure that it is up to date, this information may be different than what you see in other contexts, including when visiting the financial information, a different service provider, or a specific product’s site. All information provided in this page is presented to you without warranty. When evaluating offers, please review the financial institution’s terms and conditions, relevant policies, contractual agreements and other applicable information. Please note that the ranges provided here are not pre-qualified offers and may be greater or less than the ranges provided based on information contained in your business financing application. Lendio may receive compensation from the financial institutions evaluated on this page in the event that you receive business financing through that financial institution.

If you’re looking for lower real estate costs and longer loan terms, an SBA 504 loan may be a good option. However, these loans are a bit different from other SBA loans. 

For one thing, the loan is a combination of two loans — a traditional lender covers a portion of the loan, and a Certified Development Company (CDC) covers the rest. Before applying, it’s a good idea to learn how 504 loans work and the pros and cons of taking one out. 

What is an SBA 504 loan?

The SBA’s 504 loan program provides long-term financing for real estate, equipment, and other fixed assets. These loans are partially funded by Certified Development Centers (CDC), certified through the SBA.

The maximum loan amount is $5 million, though there are exceptions for specific energy projects. In this case, a borrower can receive $5.5 million per project for up to three projects not exceeding $16.5 million.

What are 504 loans used for? 

SBA 504 loans are designed to promote business growth and job creation through the purchase of real estate or other long-term assets. They can be used to purchase the following long-term assets:

• Existing real estate or land
• New facilities
• Long-term equipment and machinery
• Updates to new or existing real estate
• The improvement of land, streets, utilities, and parking lots

However, a 504 loan cannot be used for speculative real estate investments, working capital, or inventory. 

How SBA 504 loans work.

To complete an SBA 504 loan, there will be three parties involved:

• A Certified Development Company (CDC) - SBA-certified companies that are authorized to issue 504 loans
• A third-party lender - A bank or credit union
• The borrower - The small business owner

The small business owner applies with a Certified Development Company. The CDC coordinates a two-part mortgage between the borrower, the SBA, and a third-party lender. Fifty percent of the loan will function as a conventional commercial mortgage through a lender such as a bank or credit union. A second mortgage backed by the SBA will cover up to 40% of the loan. The remaining 10% is contributed by the owner as a down payment.

Newer businesses, defined as a business that has been in operation for two years or less, must contribute a 15% down payment. If the loan will be used to purchase or build a limited or special-purpose property, you will also need a higher down payment. The SBA defines special purpose properties as those with a unique design that restricts its use for other purposes such as a bowling alley.

How to apply for an SBA 504 loan?

Applying for a 504 loan is a bit different since the loans are only available through CDCs. You’ll start by finding a CDC location in your area—more than 200 centers are located across the U.S.

Once you’ve found a CDC, you need to get prequalified to see what your business is eligible for. Getting prequalified won’t hurt your credit score, and the process is much less rigorous than the full application process.

Once you’re ready to submit a formal loan application, you can use the 504 Authorization File Library to see what documentation you need. It typically takes the SBA about a week to approve or deny your application, but it could take several months to close on the loan and receive the funds. 

Eligibility requirements for a 504 loan.

You must meet the following requirements to qualify for a 504 loan:

• Operate as a for-profit company 
• Do business in the United States or U.S. territories
• Have a net worth below $15 million
• Have an average net income below $5 million after taxes for the two years prior to your application
• Have hazard insurance on the property being financed

In addition, borrowers have to meet general eligibility standards set by the SBA.

Pros and cons to consider

When evaluating whether a 504 loan is the right choice for you, consider the following pros and cons.

Pros

• Low interest rates - Interest rates on the CDC portion of the loan are limited by the SBA, so they tend to be lower than what most lenders offer. And the interest rate is fixed, so it won’t change throughout the life of the loan. 
• Lengthy repayment terms - SBA 504 loans also come with generous repayment terms. If you purchase equipment, you’ll have a 10-year repayment term. But real estate comes with 10-, 20-, and 25-year repayment terms.
• Low down payment requirements - When you take out a 504 loan, you’re required to pay a 10% down payment which is lower than what most commercial lenders require.  

Cons

• Comes with a personal guarantee - The SBA requires a personal guarantee on all of its loans, including 504 loans. A personal guarantee means the lender has a right to pursue the owner for loan repayment if the business defaults on the loan. 
• Rigorous application process - The SBA is known for its extensive documentation requirements—it could take a couple of months to close on the loan and receive the funds.

Can a SBA 504 loan be used for a change of ownership?

A 504 loan may be used to finance the purchase of eligible, long-term, fixed assets as part of a business acquisition. The purchase of any ineligible assets must be financed through other means such as an SBA 7(a) loan.

SBA 504 loan alternatives

If you’re unsure whether a 504 loan is the best option for your business, there are other options you can consider. Here are a few SBA 504 loan alternatives:

• SBA 7(a) loans - An SBA 7(a) loan is another loan that’s backed by the SBA. These loans are typically used for working capital, equipment, and refinancing business debt. Loans are available for up to $5 million with repayment terms up to 25 years.  
• SBA Express loans - SBA Express loans are available for up to $500,000, and the rates may be slightly higher than other types of SBA loans. But the turnaround time is less than 36 hours, so it’s a good option for anyone looking for faster funding.

The bottom line.

If you want to purchase commercial property or other fixed assets for your business, you should consider an SBA 504 loan. These loans come with a 10% down payment, low rates, and longer repayment terms. 

But if you want to put some of the funds toward working capital needs or refinancing debt, you can look into a 7(a) loan instead. If you’re ready to get prequalified for an SBA loan, you can use Lendio to quickly compare loan offers from multiple lenders.

Have you heard of selling accounts receivable? Sometimes known as factoring, this type of financing is increasingly popular due to its speed and efficiency. If you’ve faced rejection from lenders in the past, you should devote a long look at accounts receivable financing.

What does it mean to sell accounts receivable?

Selling accounts receivable (aka factoring) is a financial strategy where a business sells its outstanding invoices or accounts receivable to a third-party company, referred to as a 'factor'. The factor pays the business a significant portion of the amount due up front, then proceeds to collect the full amount from the indebted customer. This method of cash flow management enables businesses to obtain immediate funds and mitigate risks associated with delayed payments or bad debts, thus improving their financial stability.

The distinct structure of accounts receivable financing makes it stand out from most other types of small business financing. In some ways, it has more in common with the sale of an asset than it does with a traditional loan. But the result is the same, as you’re provided with the cash needed to run your business.

Let's consider a real-life scenario as an example. Imagine you own a business, ABC Manufacturing, and you have an outstanding invoice of $50,000 from XYZ Retailer, which is due 90 days from now. However, you need the funds immediately for operational expenses.

Here, you can approach a factoring company and sell your invoice. The factoring company may offer to pay 80% of the invoice value (i.e., $40,000) upfront. After collecting the full amount from XYZ Retailer at the end of the 90 days, the factoring company will then pay you the remaining balance of $10,000, minus their fees.

So, while you receive less than the full invoice amount, you get access to immediate cash that allows smoother running of your operations.

Six benefits of selling accounts receivable.

Let's delve into the advantages of this financial approach by discussing the seven core benefits of selling accounts receivable. These advantages can help businesses navigate tight cash flow situations and maintain steady business operations.

1. It removes the burden from your shoulders.

Nobody likes to track down those who owe them money. With accounts receivable, a factoring company does all the dirty work for you. They’re experts at collecting money and can do it faster than you ever would!

2. Your credit score won’t be scrutinized.

When a factoring company is deciding whether or not to approve your request, they’ll focus on the financial health of the customers who owe you money (since that’s the key to them getting paid). The credit score of your own business might not even enter the picture. This means that you probably won’t have your credit pulled, which can help keep your score healthy.

3. You can actually build your credit score.

When you have a healthy cash flow, you’re better able to meet your financial obligations. This means more prompt payments to your suppliers, partners, and landlords. The ultimate result is a boost to your credit, which opens the door to more attainable and affordable financing in the future.

4. There’s no need to risk collateral.

The lower risk associated with accounts receivable financing also means that you won’t need to put up your personal belongings as collateral. This can be a huge deal, as other types of small business financing often require you to provide collateral—which increases your personal liability.

5. Money comes fast.

There are times when your business requires expedited funding, meaning the weeks-long approval processes of SBA loans simply won’t cut it. With accounts receivable financing, you can access your money in as little as 24 hours to boost your cash flow.

6. There’s no need to worry about repayment.

Speaking of financial obligations, accounts receivable financing is nice because it doesn’t add to your list of monthly payments. The factoring company is compensated through their work tracking down your unpaid invoices, so you don’t need to worry about paying them a dime.

How to find the right factoring company.

You’ll find a range of quality among factoring companies. Some factors to consider when evaluating a factoring company include:

• Receivables percentage - This is essentially the percentage of the invoice amount that the factoring company will pay you upfront. A higher percentage could mean more cash in hand, but note that this might also come with higher fees.
• Fees - Factoring companies might charge additional fees for their services. These can include processing fees, account setup fees, credit check fees, etc. Be sure to ask for a clear and detailed fee structure.
• Customer service - The quality of customer service is crucial in this business. You'll want to work with a factoring company with a reputation for being responsive, transparent, and easy to work with. Read reviews and consider asking for references from current clients.
• Add-on services - Some factoring companies offer additional services such as credit insurance, online account access, and collection services. These can be beneficial but might also come with extra costs. Evaluate if these add-on services provide value to your specific business needs.

Types of accounts receivable financing.

As for which exact financing product is best, there are a few kinds of accounts receivable lending to consider. Let’s look at the key differences.

• Accounts receivable - This is one of the most common versions, also known as factoring. After selling your purchase orders and accounts receivables, you receive upfront cash and also a cut of the payments collected.
• Inventory financing - You can acquire a revolving line of credit for your business with this asset-based form of lending. Your inventory serves as collateral.
• Single invoice factoring - When short-term money is needed, you can advance the payment of a single invoice to increase your cash flow.

Which type of accounts receivable lending is right for you? That totally depends on your unique circumstances and strategies. Make sure to consider all the options and take the time to do your due diligence—then you’ll be in a position to make an informed decision that allows you to proceed with confidence.

Have you always dreamed of owning your own business, but don't want to start from scratch? One option is to buy an existing business. However, coming up with the funds to make such a purchase can be a major hurdle for many aspiring entrepreneurs. This is where a Small Business Administration (SBA) loan comes in handy.

In this blog post, we will discuss how to use an SBA loan to buy an existing business. Learn what an SBA loan is, why it's a great option for buying a business, and how to qualify and apply for one. Let's dive in.

What is an SBA loan?

First things first, let's define what an SBA loan is. The SBA offers various loan programs to help small businesses, including those looking to purchase existing businesses. These loans are partially guaranteed by the government, making it less risky for lenders to provide financing.

There are different types of SBA loans that can be used for buying a business, such as the 7(a) loan and the 504 loan. These loans have different eligibility requirements, interest rates, and terms, so it's important to research and understand which one is right for your specific situation.

SBA 7(a) loan

The SBA 7(a) loan is arguably the most popular SBA loan option, primarily due to its versatility. You can use it for a broad range of business purposes, including buying an existing business. The SBA guarantees up to 85% of loans under $150,000, and 75% of loans greater than $150,000. The maximum loan amount is $5 million, although the average loan size is typically much smaller. Interest rates on 7(a) loans are typically close to prime rates and are influenced by a variety of factors, including the length of the loan and whether the rate is fixed or variable.

SBA 504 loan

The SBA 504 loan is designed specifically for business expansion and major fixed-asset purchases, such as real estate or equipment. Unlike the 7(a) loan, the 504 loan involves a Certified Development Company (CDC)—a nonprofit corporation promoting economic development. Under the 504 loan program, a business owner will put down a minimum of 10%, a conventional lender (like a bank) will finance up to 50%, and the CDC will finance the remaining 40%. The maximum loan amount from the CDC is $5 million (or $5.5 million for manufacturing projects or those related to energy efficiency), making it an excellent choice if you're looking at purchasing a business with significant assets.

While the SBA 504 loan is an excellent resource for business expansion and asset acquisitions, it should be noted that it's not typically used for buying businesses in the traditional sense. The 504 loan program is primarily designed to aid in the purchase of tangible assets like real estate, buildings, and equipment, rather than for buying the entirety of an existing business. 

Hence, if your objective is to acquire an entire business, the SBA 7(a) loan is likely a more suitable option. However, every business acquisition is unique, so it's crucial to consult with a finance professional or a loan officer to determine the best financing solution for your specific situation.

Reasons to use an SBA loan to buy a business.

Now that we know what SBA loans are, let's explore why they're a great option for buying an existing business. Here are some of the top reasons to consider using an SBA loan:

• Lower down payment - Compared to traditional loans, SBA loans typically require a lower down payment, which can be as low as 10%. This makes it more accessible for buyers who may not have a large amount of cash on hand.
• Longer repayment terms - SBA loans also come with longer repayment terms, ranging from seven to 25 years, depending on the loan type and amount. This can help make your monthly payments more manageable.
• Lower interest rates - SBA loans often have lower interest rates compared to conventional loans. This can mean significant savings over the life of the loan.
• No collateral required - For loans less than $50,000, 7(a) loans do not require collateral, which can be a major advantage for buyers who may not have valuable assets to put up as security.
• Support and resources - The SBA provides support and resources to help small businesses succeed. By using an SBA loan, you can tap into this network of experts and resources to help your business thrive.

How to qualify for an SBA business acquisition loan.

Now that you know the benefits of using an SBA loan to buy a business, you may be wondering what it takes to qualify for one. While each individual lender may have their own specific requirements, here are some general factors that can impact your eligibility:

• Good personal and business credit score - Your credit score is an important factor that lenders consider when evaluating your loan application. A good credit score shows that you are responsible with managing your finances and are likely to make timely loan payments.
• Experience in the industry - Lenders want to see that you have experience and knowledge in the industry of the business you are looking to purchase. This can help assure them that you have a good understanding of how to run the business successfully.
• Strong business plan - A strong business plan is essential for any loan application, as it outlines your strategy and projections for the future of the business. The SBA also offers resources to help you create a solid business plan.
• Adequate cash flow - Lenders want to see that the business has enough cash flow to support loan payments. They will analyze the financials of the business and your personal finances to determine this.
• Down payment - As mentioned earlier, SBA loans require a down payment. Depending on the loan type and amount, this can range from 10% to 20%. Having enough money saved for this is crucial in qualifying for an SBA business acquisition loan.

How to apply for an SBA business acquisition loan.

If you meet the eligibility requirements and have found a business you want to purchase, the next step is to apply for an SBA loan. Here's a general overview of the steps involved:

1. Research lenders - Start by researching different lenders who offer SBA loans for business acquisitions. Consider their interest rates, terms, and reputation. A variety of lenders offer SBA loans, including traditional banks, credit unions, online lenders, and specialized SBA lenders.
2. Gather required documents - Most lenders will require similar documents, such as personal and business tax returns, financial statements, and a business plan. Make sure you have all the necessary paperwork ready before applying.
3. Fill out the loan application - Once you have selected a lender, fill out their loan application form. Be honest and accurate with your information.
4. Wait for approval - The approval process can take anywhere from several weeks to a few months. The lender will review your application and may ask for additional information or clarification.
5. Close the deal - Once you've been approved and have signed all the necessary documents, the funds will be disbursed, and you can officially become the new owner of the business!

Buying an existing business can be a smart move for aspiring entrepreneurs who want to skip the initial stages of starting a business from scratch. With an SBA loan, the dream of owning your own business may be more attainable than you think. Remember to do your research, work on improving your eligibility factors, and carefully compare lenders before applying for a loan.

*The information contained in this page is Lendio’s opinion based on Lendio’s research, methodology, evaluation, and other factors. The information provided is accurate at the time of the initial publishing of the page (Nov 10, 2023). While Lendio strives to maintain this information to ensure that it is up to date, this information may be different than what you see in other contexts, including when visiting the financial information, a different service provider, or a specific product’s site. All information provided in this page is presented to you without warranty. When evaluating offers, please review the financial institution’s terms and conditions, relevant policies, contractual agreements and other applicable information. Please note that the ranges provided here are not pre-qualified offers and may be greater or less than the ranges provided based on information contained in your business financing application. Lendio may receive compensation from the financial institutions evaluated on this page in the event that you receive business financing through that financial institution.

Being unable to make payments on a business loan is not a new phenomenon. Scores of hard-working business owners have found themselves in situations where they couldn’t fulfill their financial obligations. In some cases, they were late on payments. Other times, the payments were missed altogether. Some lenders are more tolerant of delinquency than others, but at a certain point, late and missed payments result in a default. 

Read to better understand how a default on a business loan typically plays out and how it could affect you.

Default vs delinquency: Understanding the difference.

Often, the terms ‘default’ and ‘delinquency’ are used interchangeably, but they represent two distinctly different stages of loan repayment trouble. Delinquency refers to missing a single scheduled payment. It’s a bit like stumbling, but you still have a chance to regain your balance. You usually have a grace period to make up the missed payment before the lender takes further action.

On the other hand, default is when multiple payments have been missed, typically over a period of 90 to 180 days. This is equivalent to falling flat on your face. At this stage, the lender assumes that the borrower is unable or unwilling to meet the loan obligations and may take legal action to recover the owed money.

So what happens if you default? That depends, as the consequences of business loan default vary depending on how you guaranteed the financing. Let’s look at three possibilities:

1. Unsecured loans 

This type of loan doesn’t require any type of collateral from the borrower in order to secure the funds (hence the name). Lenders are understandably reluctant to offer these loans as they involve higher risk. To compensate for this lack of collateral, unsecured loans usually have lower dollar amounts, higher interest rates, and shorter repayment terms.

Additionally, lenders usually require you to make a personal guarantee to receive an unsecured loan. While this isn’t technically collateral, there’s a similar impact if you default on an unsecured loan. The lender will come after your personal assets to recoup the money involved with the financing.

2. Secured loans 

While unsecured loans often need a personal guarantee, lenders take it to a more specific level with secured loans—you’ll be asked to provide collateral that meets or exceeds the value of the loan. Popular examples of collateral include homes, boats, vehicles, real estate, inventory, machinery, and accounts receivables.

In the case of a default, some lenders may be willing to work with you to find a solution. But if you’re ultimately unable to meet your payment obligations, the promised collateral will become the property of the lender. The lender will need to put time and effort into selling the asset before they actually get paid, which is why collateral must often be worth more than the actual value of the loan.

3. Secured SBA loans 

If you default on a SBA loan, your first interactions will be with the lender who funded the loan. They’ll begin the collection process outlined in the loan agreement, which usually includes the lender taking possession of any collateral attached to the loan.

At this point, the lender submits a claim to the SBA. Because the agency will have guaranteed a portion of your loan, they’ll pay the lender that amount.

The remaining debt is then transferred to the SBA. The agency will request payment from you to cover their expenses. If you’re financially able, you can resolve the situation immediately. You can also make an offer in compromise, where you explain any extenuating circumstances and request that the SBA let you settle the debt with a smaller payment than is officially required.

Assuming the SBA accepts your payment or offer, the case will be closed. When a resolution can’t be found, however, the agency submits your account to collections officials at the Treasury Department. This phase is where things can get serious, as the Treasury Department has the authority to garnish wages and take other actions to get the money they are owed.

Additional impacts of a business loan default.

The simple act of missing loan payments hurts your business credit score, so a default makes an even more substantial impact. Lenders will likely regard you as a higher risk in the future, leading to higher interest rates and shorter repayment terms on future financing.

Your personal credit score might also be affected, depending on how you set up your business. Some structures offer liability protection to owners. For example, a limited liability company (LLC) provides shelter from defaults. Sole proprietorships, on the other hand, leave the owner completely responsible for such failures.

While no small business owner ever applies for financing with the intent of defaulting, it’s wise to consider that possibility as you set up your business. Your strategy at the onset can potentially save a lot of headaches and financial losses down the road.

Avoiding default on a business loan: strategies to consider.

Avoiding a default on a business loan requires proactive planning, regular financial monitoring, and prudent business management. Here are some strategies you may want to consider:

1. Improve your cash flow - Financial health of a business largely depends upon its cash flow. Implement strategies to improve cash flow like prompt invoicing, offering discounts for quick payments, and managing inventory efficiently.
2. Regularly monitor your finances - Keep a close eye on your cash flow and financial forecasts. Regular monitoring will help you identify potential issues before they become serious problems.
3. Maintain good relations with your lender - Maintain open lines of communication with your lender. If you foresee any financial hiccups, inform your lender in advance. They may work with you to adjust the payment terms.
4. Consider loan refinancing - If your current loan repayments are becoming difficult to manage, loan refinancing might be an option. It could help you secure lower monthly payments, but be aware that this could mean you'll be paying more in total over a longer period of time.
5. Seek financial advice - If you're struggling to manage your business finances, seek advice from a financial advisor. They can assist you in reviewing your financial situation and suggest ways to manage your debts effectively.

Remember, business financial management requires consistent attention and action. By adopting these strategies, you can significantly reduce the risk of defaulting on your loan.

What to do after your loan goes into default.

If your business loan has already gone into default, don't panic. There are still steps you can take to mitigate the situation:

1. Communicate with your lender - Reach out to your lender immediately. Transparency about your financial situation can lead to a cooperative and understanding approach from the lender. They may provide options for loan restructuring or deferment.
2. Consult a financial advisor - This is a critical step. A financial advisor can guide you on how to navigate this predicament. They may suggest ways to consolidate your debt or advise on possible legal implications.
3. Evaluate your financial situation - Take a hard look at your finances with the goal of freeing up resources to repay your debt. Identify areas where you can cut costs and increase revenue. 
4. Consider selling assets - If you have assets that you don't need and can easily liquidate, consider selling them to pay off your debt.
5. Negotiate with the lender - If your financial situation is dire and there's no way you can pay back the loan in the near future, consider negotiating with the lender. They may agree to reduce the debt or modify the terms to fit your current ability to repay.
6. Explore legal options - If negotiations fail or aren't an option, you might want to explore legal options like bankruptcy. However, this should be your last resort, as it would severely impact your credit score and reputation. Always consult with a legal advisor before choosing this path.

Remember, defaulting on a loan is serious, but not the end of the world. There are always options available to get your business back on track.

While landing a big deal might sound amazing for your business, if you don’t have the funds available to support production, you’ll stretch yourself too thin. It’s not uncommon for companies to have large sums of accounts receivable invoices that aren’t accessible. The business must meet its obligations and collect the money from the business before that revenue is actually recognized.

Fortunately, there are options for businesses to access some of the money that’s wrapped up in unpaid invoices—and invoice factoring is one of these options. Learn more about invoice factoring below.

What is invoice factoring? 

Invoice factoring is a process that enables businesses to get immediate cash by selling their outstanding invoices. 

When a business issues an invoice to a customer, it may take up to 90 days for the customer to pay. With invoice factoring, a factoring business can purchase the invoice, pay the business for it, and then collect the payment from the customer. This way, the business gets the funds it needs without having to wait for the customer to pay, and only pays a small fee to the factoring company for the service.

What are the benefits of invoice factoring?

Depending upon your customer base and the state of your account receivables, invoice factoring is usually much easier and faster than securing a conventional loan. What’s more, the factor is more interested in the creditworthiness of your customers than whether or not your credit is perfect. So even if your credit score is below average, you could still qualify for this type of financing, if the other aspects of your business are strong.

Some factoring companies specialize in specific industries and business types. Finding a factor that specializes in your industry could improve your chances of approval.

How does invoice factoring work? 

Let's delve into the nuts and bolts of how invoice factoring actually functions in the business world.

1. Invoice generation - The first step of invoice factoring starts with your business generating and issuing invoices after delivering products or services to your customers.
2. Selling the invoice: - Next, instead of waiting for your customer to fulfill the invoice payment, you sell your invoice to a factoring company.
3. Factoring company pays - The factoring company reviews the invoice and if approved, pays you a significant percentage (typically 70% to 90%) of the invoice value immediately.
4. Customer payment - The factoring company then takes over the collection process. Your customer is informed about the new payment arrangement, and they will pay the invoice directly to the factoring company.
5. Receiving the remaining balance - Once the customer pays the invoice in full to the factoring company, you'll receive the remaining balance of the invoice, minus the factoring fee.

It's essential to note that the process can vary between different factoring companies. Always make sure to understand the terms and conditions before engaging in invoice factoring.

Factoring example

Let's consider a practical example to better understand the concept of invoice factoring:

Suppose you run a wholesale business, and you have issued an invoice of $10,000 to a supermarket. The payment terms are net 90 days, but you need the funds immediately to restock your inventory. Instead of waiting for the supermarket to pay the invoice, you decide to use a factoring company.

You approach a factoring company and sell them your invoice. The factoring company reviews the invoice and agrees to buy it. They pay you 80% of the invoice amount up front, which is $8,000. This allows you to restock your inventory and continue operating your business smoothly.

Once the supermarket pays the invoice, the factoring company receives the full $10,000. The factoring company then sends you the remaining 20% of the invoice ($2,000), but deducts a 3% factoring fee. So, you receive $1,700 ($2,000 - 3% of $10,000).

In the end, you received $9,700 of the $10,000 invoice and paid $300 for the factoring service, which enabled you to keep your business running without any cash flow problems during the 90 days you would have otherwise been waiting for payment.

How much does factoring invoices cost?

An important consideration when deciding whether a factoring loan is a good choice is the lender fee. While some factoring companies will charge small fees to buy your invoice (around 3%) others can take out larger amounts, ranging from 10% to 15%. In high-risk cases or when you’re working with predatory firms, they might take out 30% of the total invoice as their processing fee. 

As a business owner, you need to decide how much you can afford for invoice factoring. At what point will the fees related to the invoice purchase cut too deeply into your profit margins? By seeking the funds immediately instead of waiting for the invoice to get paid, you could end up losing more profits and limiting your growth.  

Is factoring invoices a good idea?

Like all financial decisions, there are pros and cons of opting for invoice factoring. Some of the benefits or drawbacks might weigh heavier on your business, depending on your current situation. 

Pros

• Lenders are less concerned about your credit score and company history. This could be a viable option if your business has poor credit or is just starting out. Instead, the lender focuses on the invoice itself and its likelihood of getting paid. 
• Your invoice will get paid quickly. You will receive the cash in seven to 10 days in most cases, giving you a boost to your cash flow to cover operating expenses. 
• You can return to the lender frequently, as you don’t have to worry about requalifying after your invoice gets paid. If you have another invoice that you want to be cashed, you can approach the factoring company a few days later. 
• You don’t need collateral. Your assets aren’t at risk because the lender doesn’t care as much about your company—they’re only focused on the invoice. 

Cons

• The fees can be expensive and will eat away at your profit margins. In the worst-case scenario, you could lose money on the invoice because of the fees. 
• Invoice factoring is typically for B2B companies. If your business works primarily with individuals, you may have a harder time getting funded. 
• Your customer relationship might be at risk. The factoring company will deal with the invoice collection process after they buy it from you. If the company is aggressive and unethical, your customers might not want to work with you again as a result. 
• Your customers could derail your financing. If your customers have a history of late payments or poor credit, then the factoring business might not want to cover your invoice. While the lender doesn’t care about your finances, they’re deeply concerned about your client’s standing.  

The option to use an invoice factoring company depends on the business you use. There are ethical companies that are happy to work with businesses of all industries and predatory factoring agencies that charge high fees and go after invoices aggressively. Do your research before making your choice. 

How to qualify for invoice factoring.

To qualify for invoice factoring, certain criteria must be met by businesses.

1. Volume of invoices - Factoring companies typically require a certain minimum amount of invoices. This may be a specific number or a total value.
2. Creditworthy customers - Since the factoring company will collect payment directly from your customers, they must be creditworthy. The factoring company will likely investigate your customers' credit history as part of their decision-making process.
3. B2B operations - Your business typically needs to be a B2B (business-to-business) operation. Factoring companies prefer businesses that issue invoices to other businesses, rather than B2C (business-to-consumer) businesses.
4. Unencumbered invoices - The invoices you want to factor must be free of any legal claims or encumbrances. This means that they cannot be pledged as collateral for another loan.
5. Industry - Some factoring companies only work with specific industries, while others are more flexible. It's important to verify that your business operates in an industry that the factoring company services.
6. Time in business - Some factoring companies require that your business has been operational for a certain length of time, although this is not always the case.

Remember, different factoring companies may have slightly different requirements, so it's essential to research and confirm the criteria for each prospective factoring company.

How to evaluate factoring companies.

Evaluating factoring companies involves several steps to ensure that you're choosing the right partner for your business. Here are some key aspects to consider:

1. Recourse vs. non-recourse factoring - Factoring can be either recourse or non-recourse. With recourse factoring, if your customer doesn't pay the invoice, you are responsible for repaying the amount to the factoring company. Non-recourse factoring means the factoring company assumes the risk if the customer fails to pay. While non-recourse factoring may seem more attractive, it usually comes with higher fees due to the increased risk for the factoring company.
2. Spot factoring and single-invoice factoring - Some factoring companies offer spot factoring or single-invoice factoring, allowing you to factor just one invoice at a time. This can be a great option if you need cash flow help only occasionally. However, keep in mind that the fees for spot factoring can be higher than if you commit to factoring a certain volume of invoices.
3. Factoring fees and advance rate - Understand the fees associated with the factoring service. They can range from 1% to 5% of the invoice value, depending on the factoring company and the risk involved. Also, look at the advance rate, which is the percentage of the invoice amount that you receive upfront. A higher advance rate can mean more immediate cash for your business.
4. Contract terms - Look closely at the contract terms. Some factoring companies require long-term contracts or a minimum volume of invoices, while others offer more flexibility.
5. Reputation and customer service - Research the factoring company’s reputation. Read reviews, check their Better Business Bureau rating, and ask for references. Additionally, consider their customer service. You want a factoring company that will respond promptly and professionally to your inquiries.
6. Industry experience - It's beneficial if the factoring company has experience in your industry. They will be more familiar with industry practices and any specific challenges that might come up.

By taking these factors into account, you can better evaluate factoring companies and choose the one that best fits your business's needs.

Invoice factoring vs. invoice financing.

It's easy to confuse invoice factoring with invoice financing as both methods involve using unpaid invoices to improve cash flow. However, there are key differences to understand.

Invoice factoring

As detailed above, invoice factoring involves a business selling its invoices to a factoring company at a discount. The factoring company then takes responsibility for collecting the invoice payments from the customers, freeing up the business from the time and effort of chasing these payments. The business receives immediate funds, which can be vital for maintaining smooth operational activities, especially for B2B companies.

Invoice financing

On the other hand, invoice financing is essentially a loan where the unpaid invoices serve as collateral. With invoice financing, the business retains control and responsibility for collecting the debts from its customers. The lender provides an advance of a portion of the invoice value (usually between 80% and 90%), and the business repays this advance plus fees once the customer has paid the invoice.

While both methods provide quick access to cash, they differ in terms of responsibility and risk. With invoice factoring, you relinquish control of your customer relationships to the factoring company, but you also rid yourself of the risk of non-payment. In contrast, with invoice financing, you retain control of your customer relationships, but you also hold the risk of non-payment as you're responsible for repayment of the advance regardless of whether your customer pays their invoice. As with all financial decisions, it's crucial for businesses to understand these differences and evaluate which option aligns best with their needs and circumstances.

Types of invoice factoring.

There are three types of factoring options you should be aware of:

1. Full-service factoring – The factor assumes full responsibility for and control of collecting the debt, even if the customer never pays the invoice. The factor assumes all the risk. As you might expect, this type of factoring carries with it a higher discount when they purchase your invoices.
2. Recourse factoring – If your customer doesn’t pay the invoice, you are obligated to buy it back. Recourse factoring allows you to sell your invoices at a small discount and is great if your customers have a history of paying on time.
3. Spot factoring – Spot factoring, also called single-invoice factoring, follows the same process as invoice factoring except you are selecting a single outstanding invoice to factor rather than a group of invoices.

When looking for a factor, be aware that they are not all alike. Interest rates and terms can vary greatly. It’s easy to find this type of financing online. Lendio‘s network partners with multiple factoring and other financing companies to compare multiple offers so you’re sure you get the best deal on your next business move.

There are many ways to become an entrepreneur. You can launch your own business from the ground up, you can partner with someone else, or you can even buy a small business outright.

Buying a small business can create a unique stream of income and help you to launch your new career—you just need to know where to find them and how to invest. 

Buying a business, as opposed to starting something from scratch, can streamline your path to profitability. It can also be less risky, in some cases, if the brand is already successful and established.

If you’re considering purchasing an existing small business, this guide will help. Learn where to buy a small business, as well as the pros and cons of different business types.

How to buy a small business

1. Figure out what type of business you want to buy

2. Where to find small businesses to buy

3. Do you want to buy an existing business or a franchise?

4. Know yourself before you buy a business

5. When is the right time to buy a business?

6. Understand why an existing business is up for sale

7. Decide on a business that fits your needs and resources

8. Creating a plan for buying a business

9. Do your due diligence

10. Financing your business acquisition

11. Closing the deal

12. Know the benefits of buying a business

13. Keep the downside in mind

Figure out what type of business you want to buy

Not all businesses are created equal. In fact, each one is unique and has its own value proposition and business model. The type of business you buy should align with your particular experience, skills, passions, and interests. 

If you’re passionate and knowledgeable about real estate, for example, a business in the real estate industry should be on your radar. You’ll be less likely to succeed if you’re new to real estate, unfamiliar with industry jargon, and what it takes to thrive. In addition, it’s essential that you agree with the business goals and be willing to work hard to achieve them. Otherwise you may be unmotivated to steer the venture toward success.

Where to find small businesses to buy

There are many ways to find small businesses to buy in your area or industry. You may want to try multiple methods to discover businesses so you can find the best option for your investing goals. 

• Deal directly with the business owner. Are you looking to acquire a smaller company or competitor in your field? Do you want to enter a new industry or market? One of the best places to buy a business is directly through the other business owner. Do your research, and when you find a business that you want to pursue further, reach out to the owner and discuss the opportunity of purchasing their business directly.
• Hire a business broker. Business brokers work to connect small businesses with potential buyers—and vice versa. Their job is to understand various industries and company values. They can also provide insight into which businesses to avoid and share context into the history of various organizations. 
• Find businesses online. Sites like BizBuySell and BizQuest allow small businesses to list their brands and connect with buyers. You can sort by industry, location, and even price. This is a great place to get a feel for your local markets and customer demand. 

You might also want to keep a lawyer on retainer to help negotiate the sale and handle various contracts related to the transition. This extra assurance can give you peace of mind and help you to protect your investment.

Do you want to buy an existing business or a franchise?

You don’t only have to look for small or local businesses to buy—it’s also possible to buy a franchise of an existing business and operate under that brand. Companies like McDonald’s, ACE Hardware, and Massage Envy rely on franchisees to buy into their businesses and operate companies on their own. 

Buying a franchise has its pros and cons, as explained by the Small Business Administration. One of the main benefits: support. There will be less decision-making because the brand and its processes are established and set. For example, if you decide to open an ACE Hardware, you’ll already know the brand’s color choices and the employees’ uniforms. You’ll also gain access to the company’s internal systems and marketing materials. 

While some people embrace the structure of opening a franchise, there are also limitations to what you can do. You can’t get creative with new products and must stick to established guidelines. This might not be ideal if you want to build a unique business or want more influence on the systems within the organization.

You can find franchises for sale across almost any industry or company size. Different franchises have different license fees and varying startup costs. For example, it costs more to build an Anytime Fitness than a PJ’s Coffee stand. Some franchises require $250,000 or more to get started, but others require much less. To explore different franchise opportunities and costs, look at sites like Franchise Direct or Franchise Gator to learn more. These sites can help you to find the best franchises to own based on your budget and goals.

Know yourself before you buy a business

You may be tempted to buy your favorite bar that can’t afford to stay open or invest in a bakery based on your passion for cake design—however, it’s important to be realistic about what you know and what you can handle. There are a few key factors to consider with your business choices:

• How much time do you have to run this business? Are you looking to acquire a company and run it day-to-day as a full-time job, or do you want to be a silent partner who is more hands-off? You may want to look into a business investment rather than exclusive ownership if you don’t plan to be involved in the operations of the company.  
• What is your expertise in the field? How much do you know about the industry, the current local market, and the business plan of the business you want to acquire? Think about the “cupcake bubble” of the past decade, where the market became too saturated with cupcake shops as the trend faded. You may need to spend some time learning about the industry before you enter it.  
• What is your expertise in business? Even if you have industry experience, you may need additional business acumen to succeed. Take steps to bolster your accounting, marketing, HR, and management expertise to prepare yourself to lead your employees to success. 
• How will you fund the investment? You can absolutely follow your dreams of becoming a business owner, but you need a funding plan first. Look into a loan to buy a business and other professional funding options—this way, you’ll have enough money to acquire the company and make any modifications needed.

You don't have to have an MBA or 10+ years of experience in a field to buy a business. However, you will need a plan to manage your finances, operations, and marketing as soon as the business becomes yours.

When is the right time to buy a business?

The right time to acquire an existing business is when you find one with a good labor pool, a strong customer base, established procedures, growing sales, and most importantly, positive cash flow. It should also be the type of business where you can leverage your strengths and your experience. Once you find what you’re looking for, get in contact with your attorney and your banker to thrash out the details.

Existing cash flow and a proven track record will make it easier for you to secure financing for the venture of your choice. You’ll have better access to cash flow once your customer base is good, and you have strong distributor and supplier relationships in place. All of these factors save you a lot of time and money. You may also be able to draw on the experience of the previous owners if they are willing to guide you as you take over the business.

Understand why an existing business is up for sale

Before you sign on the dotted line and purchase a business, determine why it’s on the market in the first place. Maybe the owner is ready to retire. Or perhaps there are serious issues with the business, like a damaged reputation or poor product line. Don’t be afraid to ask the current owners why they’re selling their venture and what challenges they’ve encountered over the years.

You should feel confident that you can solve these challenges or can find resources that can help you do so. Some of the most common challenges you might come across include a poor business plan, excessive business debt, location issues, branding confusion, outdated equipment, and staffing shortages. 

Take the time to learn as much as possible about the successes, failures, challenges, and opportunities of the business. In addition to the owner, consult current and former customers, employees, and competing businesses. They’ll provide you with an unbiased opinion of how the business is performing and why it’s for sale.

Decide on a business that fits your needs and resources

After you shop around and consider all your options, it’s time to make a decision. The right business will line up with your budget, goals, and resources. Once you hone in on the ideal venture, do the math and figure out the best size, location, sales strategy, and staffing needs.

If you know you’d like to make drastic changes, determine what resources you’ll need to implement them and how much they’ll cost you. Remember to think about the time and energy you’ll need to invest in addition to the monetary cost. 

The money, time, and energy you’ll have to invest will depend on the business type and your particular experience and connections. For example, if you’ve worked in real estate in the past and are purchasing a real estate business, you’ll have to invest less than you would if the industry is entirely new to you.

Creating a plan for buying a business

There’s no way to proceed confidently with a business purchase unless you have a plan. And the process of creating your plan will make it possible to determine whether or not the timing is right for you.

The best way to build your business plan is to answer questions related to your motivations and goals. Here are some possible questions to think about:

• What’s driving you to buy a business now?
• How much experience do you have in the industry?
• How passionate are you about the industry?
• What’s your mission statement?
• What’s your main objective?
• What are your primary strategies?
• What has your market analysis revealed?
• What has your competitor analysis revealed?
• What will your financial needs be?
• What are your financial projections?

You won’t have all the answers up front—research and review will be required for clear answers. But you should start the process now in order to proceed when you feel the time is right.

“Research and analyze your product, your market, and your objective expertise,” explains a business report from the Houston Chronicle. “Consider spending twice as much time researching, evaluating, and thinking as you spend actually writing the business plan. To write the perfect plan, you must know your company, your product, your competition, and the market intimately.”

Once you’ve compiled your business plan, you’ll be able to confirm your choices regarding timing and whether you should buy a business or take the franchise route. A business plan is a living, breathing thing—you’ll want to revisit it regularly to make sure it reflects your current situation and aligns with your future goals.

Do your due diligence

Due diligence is when you collect as much information as you can before you go ahead and purchase a business. It’s a good idea to work with professionals, like a lawyer and an accountant to make sure you have all your ducks in a row before you move forward.

While the accountant can help you with financials, an attorney may support you with negotiations and all the legalities of the purchase. Be prepared to sign a nondisclosure or confidentiality agreement and agree that you won’t reveal any confidential information you learn as you do your due diligence. In the event you decide to back out of the deal, this agreement will protect the seller. 

There is no shortage of documents and statements you’ll want to gather during the due diligence process. Several of the most important ones include: 

• Business licenses and permits - The business you’re interested in should already have all the licensees and permits it needs to operate legally. If the business is in a highly regulated industry (Ex: childcare) you won’t be able to stay open without them. 
• Organizational paperwork - This involves documents that state the business has been officially registered as an LLC or corporation. An LLC requires an articles of organization, while a corporation must come with an articles of incorporation. A certificate of good standing from the secretary of state is crucial as well. 
• Zoning laws - Make sure that the business operates in accordance with all zoning laws. Some localities impose serious restrictions on where certain businesses can and cannot be located. 
• Environmental regulations - There are many environmental regulations for small businesses set forth by the Clean Air Act, Safe Drinking Water Act, Pollution Prevention Act, and more. The business you purchase should be in accordance with them. 
• Letter of intent - Also known as an LOI, the letter of intent is written by the seller after you’ve agreed on a price, as well as which assets and liabilities will be included. The conditions of the sale should also be outlined in the LOI. 
• Business financials - You’ll need to work with an accountant to review a few years of various financial documents. Some of the most popular ones are tax returns, income statements, cash flow statements, balance sheets, and debt disclosures.
• Organizational chart - An organizational chart will come in handy as it will inform you of all of the current employees and how they relate to one another. Ideally, the chart will also include details on compensation, benefits, PTO, and management processes. 
• Other documents - The particular business and industry will determine any other important documents. Ask your accountant or attorney if there is any additional paperwork or forms you’ll need. 

Financing your business acquisition

Most small businesses close their doors for one reason or another within a few years of starting up. An existing company gives you the advantage of business systems that have been honed over time.

If you have the funds to make a 10-20 percent down payment, industry experience or business management skills, and good credit scores, an SBA loan would be ideal. If yours is a large business, you can apply to the big banks (this is one of the toughest sources of financing for small businesses to tap into).

On the plus side, it can be easier to get financing for an existing business than for one that has not yet proven itself profitable. Take the case of a reputable business with an asking price of $500,000, and steady yearly cash flows of $200,000. Match that with taking out a $300,000 loan to bankroll a startup, where forecasts may or may not be realized. A bank may be more prepared to fund the half-million deal if you have a realistic down payment, and if the company you're purchasing has historic income and adequate cash flow to service the debt.

Closing the deal

Last but not least, you’ll close the deal. After you’ve found the right business, performed your due diligence, agreed on a price, and collected all the capital you need, you can officially purchase the business. Here’s what’s involved in the closing process: 

• Bill of sale - The bill of sale will prove the sale of the venture and officially transfer the business assets and ownership to you. 
• Adjusted purchase price - This refers to the final cost of your purchase and includes rent, utilities, inventory, and other prorated expenses. 
• Lease - A lease is important if you plan to take over the current lease of the business. If you’d like to negotiate a new lease, be sure to work with the landlord and finalize its terms.
• Vehicle documents - Vehicle documents are key if your business will come with vehicles. You’ll need to work with the local DMV to transfer ownership. 
• Trademarks, copyrights, and patents - If you have negotiated for them,  when you purchase a business, every patent, copyright, trademark, and related form become yours. 
• Employment or consultation agreement - If the seller will help you through consulting services during the transition process or work as an employee, be sure to create an agreement. Additionally, if there are key employees, they should also be signing new employment agreements with your entity. 
• Franchise agreements - If the business follows a franchise model, franchise agreements will outline the rules and regulations you'll need to follow.

Know the benefits of buying a business

While you can start a business from scratch, investing in an already established venture comes with many benefits, including:

• Established brand and reputation – Buying an existing business comes with an established brand and reputation in the market. It takes time and effort to build a brand from scratch, and it can take years before you start seeing a significant return on investment. On the other hand, buying a business that already has a loyal customer base and a solid reputation in the industry means you can hit the ground running.
• Pre-existing customer base – Purchasing a business with an existing customer base is one of the biggest advantages of buying a business. A loyal customer base is the backbone of a successful business venture, and buying an existing business ensures that you have immediate access to this customer network. You can leverage these relationships to generate sales and build a stronger customer bae.
• Established processes and operations – When you buy an existing business, the processes and operations are already established. You don’t have to waste time and resources trying to figure out the best ways to run the business. Instead, you can focus on improving, streamlining, and optimizing those processes.
• Existing staff – Another significant advantage of buying a business is that it comes with a pre-existing workforce. You don’t have to recruit, hire, and train a new team from scratch. Instead, you can acquire a knowledgeable team that already knows the ins and outs of the business. Additionally, existing employees can be a source of valuable insight and knowledge.
• Proven financial track record – Buying an established business also means you have access to the business’s financial track record. You can analyze its revenue streams, profitability, and other financial metrics to determine the business’s overall health and profitability. You can also use this data to make informed decisions about how to grow and scale in the business.
• Financing flexibility – Along with a proven track record, you’ll have financing flexibility. When lenders and investors see you want to purchase a business with a successful track record, they’ll be more likely to lend you money. There’s no need to prove your business concept or potential worth.
• Access to intellectual property - As the new business owner, if you purchased them, you’ll enjoy all the rights to the slogan, logo, and other intellectual property that can be costly to obtain when you initially start a venture. 
• Reduced risk - There's no denying that starting a business comes with a great deal of risk. When you purchase an existing one, you'll already have a strong foundation and can focus your efforts on improvements and innovations.

Keep the downside in mind

On the downside, purchasing a business is often more expensive than starting from scratch. Think long and hard about the kinds of establishments you’re attracted to and which best match your experience and skills. You can find great ventures for sale if you contact a business broker. If you’d like to go it alone, you’ll need to take several things into consideration, such as business size, geographical area, and industry.

You also have to consider that the owner may try to downplay any business problems. These problems may be inherent, and may not become apparent until after the sale. Existing staff can offer valuable insight into areas that can be upgraded and how the business runs, and they can give you an active perspective of the business as opposed to the theoretical one you’re likely to get from the boss.

Another problem is that equipment and inventories may be obsolete. In addition, customers may owe the business, and these bills may be virtually uncollectable, making them worthless.

There are other disadvantages to purchasing a business, and you must obviously consider them seriously versus the advantages. When you’re negotiating a business acquisition loan, you must assess the existing operations of the venture thoroughly and diligently, which can be an overwhelming task.

If a business is doing badly, scrutinize it to find out what the reasons are. Inadequate resources and poor management are two common causes. Your investment may turn out to be lucrative if you can turn the business around and make it profitable; on the other hand, you’re taking a huge gamble if it doesn’t work out.

See your funding options for a business acquisition loan. Lendio will ask you a few basic questions, and will narrow down the lenders that are right for your purposes. Doing business this way saves you a lot of time, and it will help you take over your business and start making a profit much sooner than if you take the traditional route.