If you read my post Complete List of 21 Marketplaces to Buy a Website, then you know I’m planning to acquire an online business.
The next step I’m choosing to take is to secure financing for my eventual purchase. I’ve been casually browsing several of my favorite marketplaces, but I haven’t begun writing down my requirements for my future website.
Partially because my real estate investing experience has taught me that have pre-approval for your investments makes it much, much easier to make your offer and move quickly. At least in real estate, being able to move quickly is often the factor that decides who gets the deal done. So I’m hypothesizing that the same could be true in online business acquisition.
And partially because several of the website brokers require proof of funds before they allow you to view most of the details of their listings.
1. Ask Questions To Lenders
There are basically two ways to finance an investment purchase. The first is to have all the money up front. A business costs $100,000 and you save up $100,000 and pay for the business.
The second way is to borrow the money you need to purchase the business. To get a loan.
You don’t need an article to explain to you how to save money. It’s simple (not necessarily easy). I’m going to talk about the process I’m going through to get someone to lend me the money for an online business.
Why I borrow instead of saving
First, I want to briefly explain why I’m not saving up the money to buy my business. Mostly, it comes down to cash flow. I measure the success of my investments primarily by looking at cash on cash return, and secondarily by looking and overall return on investment.
A quick example can show how my cash on cash return will be far superior if I borrow money instead of saving it.
Let’s say I found an online business making $1,000 per month, and that it’s being sold for $35,000.
If I save $35,000 and buy the business, then my cash on cash return will be 34% ($1,000 x 12 ÷ $35,000). I’ll make back my initial investment in about 3 years.
If I put 10% down ($3,500) and get a $31,500 loan at 5% for 15 years, then my loan payments will be $250 per month. That means I’ll be making $750 per month ($1,000 – $250).
So if I borrow to buy the business, then my cash on cash return will be 257% ($750 x 12 ÷ $3,500)! I’ll make back my initial $3,500 investment in under 5 months.
That’s why I don’t save. I make WAY more money by borrowing.
Start with one lender
Kate and I have used three different lenders (banks) for our real estate investments, and we found these three only after meeting with ten different banks in our area.
But this time I’m trying to learn more about lending for a new asset, so I just reached out to one bank first.
I wanted to know what could be possible for me. Then when I feel more comfortable with the terms I might expect, I’ll start emailing lots of lenders.
If you don’t know exactly what you want to ask, then just be generic, like this:
“I’m looking to purchase an online business and I’m interested in getting a loan to do so. Would you be able to talk me through what you look at when you’re deciding whether to give out a loan?”
I actually just called the customer service number for a local branch of Central Bank in my city. I talked to the customer service person, told them what I wanted to do and asked if they could connect me with a lender.
Then I got a phone call from a lender and started asking questions.
Once you’ve gone through the process of getting a loan to invest a few times, you start to understand what bankers look at when approving a loan.
Doing it the first time is hard. You’ll ask some stupid questions. But it turns out that’s the only way to not be stupid anymore. So just ask anyways.
Here are some of the questions I’ve asked to my lender in the past:
- Do you lend to new investors?
- What is your process for pre-approving a loan?
- What factors do you consider in your loan approval process?
- How do you determine what is an acceptable down payment?
- Do you approve loans with low down payments?
And here are some more informed questions I’m asking this time around:
- What debts and assets do you include when calculating debt to income ratio?
- Is there a way I can get some of my investments removed from my debt to income ratio calculation?
- Can the income from the business I’m purchasing be applied to my income to qualify for the loan?
- Can assets from the business be used as collateral for the loan?
- After my business purchase, how soon can it be considered a self sustaining investment?
What I’ve learned
Most of our lending experience is with move-in ready homes. The last loan we got, a couple of our normal lenders turned us down. They told us our debt to income ratio was unsatisfactory.
I was shocked to be honest, we’re making more money now than we ever have before, but were having a harder time getting a loan. Turns out, even if your investment is cash flowing, it can negatively affect your debt to income ratio, making you less attractive to lenders.
So most of my questions revolved around this problem.
Fortunately, there are different types of lenders with different rules. This time around I reached out to a commercial lender.
He told me that they can treat your investments as self sustaining, and so they don’t count against your debt to income ratio. So if your investment is cash flowing, it can’t count against you.
That’s a game changer.
It means that as long as I can always acquire a cash flowing asset, then the only thing working against me is my ability to acquire the cash flow a down payment. I should be able to invest again as soon as I have the money for a down payment.
2. Reach Out To Multiple Lenders
I got answers to my questions from the first lender, but usually it’s a good idea to request loan approval from a few different lenders. I’ve used a bank as my lender for every investment I’ve made so far, and I believe banks are the best lenders.
Banks give you longer terms and usually better interest rates as well. And that all means better cash flow for you.
I don’t bother with big national or international banks like Bank of America or Wells Fargo. These banks have lending rules set by their corporate offices and their loan officers have virtually no flexibility.
I want a somewhat local bank, with a loan officer I can talk to in person, and who has the flexibility to work with my specific situation.
It’s not always obvious which banks are best for investors, so you have two options.
First is to ask around. If you have a real estate agent, ask them which banks are most flexible for investors. We’ve gotten some good recommendations from out realtor.
Second is to just contact banks and ask.
One of our first big failures in real estate investing was putting an offer on a house without having the financing in place already. We ended up having to back out of the deal and lost our earnest money.
After that we decided to take a few hours one day and just call every bank in our area to schedule a meeting with a loan officer. We looked stupid a few times, but we quickly learned the lingo and what questions to ask. And ultimately we found a few banks interested in working with us.
Personal financial statement
Lenders will need several things from you to do their underwriting process and make you an offer for a loan. They’ll need two years of tax returns, pay stubs, and proof of any other income. They’ll also run a credit check on you.
But their way of getting a full picture of your finances is the personal financial statement.
It’s basically a document full of every asset and debt on your record.
- School loans
- Car loans
- Real estate owned
- Cars owned
- Yearly salary
- Rent collected
- Bank account balances
- Retirement accounts
- Other assets
The point is to arrive at a few bottom line numbers. One is of course your net worth. Banks care about net worth, but when it comes to lending they tend to care more about your cash flow situation.
So another bottom line is your debt to income ratio. It’s a number that reflects your ability to make a monthly loan payment.
Note: most banks will accept a personal financial statement from another bank, so don’t fill one out for every lender.
3. Get The Best Offer
It’s tempting, particularly when you’re new to investing, to just use the first lender who approves a loan for you. But make sure you hear from at least two lenders before making a decision.
Most savvy homeowners know to look for the lowest interest rate on the fixed rate mortgages, but investors know that there are a lot of factors impacting their returns.
Let’s start with the obvious metric: interest rates. It doesn’t take a rocket scientist to know that a lower interest rate means you pay less money. All other things equal, you want the lowest interest rate.
I typically like lower down payments for two reasons. First is that I need less money to invest. Second is that I get better return on investment.
Cash flowing $150 per month on $10,000 down (18% cash on cash return) is better than cash flowing $250 per month on $20,000 down (15% cash on cash return).
Know your personal investment standards and know how different down payments affect your ROI.
Requirements for “self-sustaining” status
I mentioned earlier that commercial lenders can consider a cash flowing investment to be self sustaining, and thus not count it’s debt against your debt to income ratio.
So if I buy a new website, at what point will the lender consider it self sustaining? Will they need 6 months proof of income after closing? 12 months? Can it already be considered self sustaining at closing if the website I’m buying has 12 months of income?
The faster I can reach that status, the happier I am. It means I can get another loan to invest faster and ultimately build my wealth faster.
Other loan terms
There are lots of smaller items that can make a difference in your profitability.
For example, there are fixed rate mortgages and adjustable rate mortgages. Fixed rate mortgages are great when you plan on carrying the debt for a long time without touching it. And adjustable rate mortgages are great for investments where you plan to actively use your debt and equity.
Some banks will only give you a 20 year term where others might give you a 25 or 30 year term. This can definitely affect your cash flow.
Some loans have points, which are similar to a down payment, except they are just fees you pay to the lender, they don’t count towards your equity in the asset.
Trust the numbers
I’m sure plenty of investors will tell you that sometimes the human aspect matters more than the ROI. I don’t follow that line of thinking, personally.
I trust my calculations and I try not to let personal feelings affect which lender I use.
It’s great if you can form a relationship with your lender and continue to use them over and over again through the years. But even if you have that relationship, I think you should still shop lenders with every investment and see if anything better comes along.
4. Head To The Marketplaces
I think many investors will only worry about financing after they find an investment they want to buy. But again, I prefer to secure financing first, because then I can act faster when I find a good deal, and I can gain access to more data on some marketplaces with a proof of financing.
So now it’s time to head to those online business marketplaces and start searching for the perfect business to acquire.
In order to find the best financing situation for my online business acquisition, I worked with several banks to get pre-approved for the purchase of a business.
My most important criteria were finding low down payments and the quickest path to having the bank consider the investment self sustaining. I prefer to work with at least two banks with every investment so I have some leverage for getting better terms.
There have been a few times I’ve gotten better interest rates just from saying that another bank gave me a better rate.
Now that I have my financing in order, it’s time to start the search for my new web-based business.