Editor Note: we know that buying online businesses can be a tricky business. As Mark suggests below, make sure you educate yourself and only choose an option that will work for you.
While there are a lot of great reasons to buy an online business rather than starting from scratch, there’s always one major objection: buying an established website takes money. And the more established a website is, the more it will cost you.
Of course, you can sift through an auction marketplace looking for a bargain deal, but these marketplaces are fraught with fraud and snake-oil salesmen. Plus, many of the websites for sale through marketplaces simply don’t make enough money to justify the time you’ll spend building them. With smaller sites, you’re often better off starting from nothing.
So how can you afford to buy an established website? This article will cover 8 of the most common options we see buyers exercise to fund an acquisition. I’ll also review the benefits and drawbacks of each option.
1. Cash Reserves, Stock, Bonds
Not everyone has access to enough cash reserves to buy a premium website, but for those who do have enough value built up in savings, stocks, bonds, and other liquid assets, cash is a great option.
- Sellers Love Cash Buyers. Sellers love to work with buyers who pay with cash since cash buyers tend to move quickly and decisively.
- Your losses are limited to your investment. Hopefully, your acquisition doesn’t fail, but if it does, you only lose the cash invested. While this isn’t a great outcome, it’s better than losing a home you used as collateral for a loan to buy the website.
- Freezing a liquid asset. The biggest disadvantage to buying with cash is that you are moving a liquid asset into a non-liquid asset. In other words, when you have cash, you can do just about anything you want with it. When you buy a business, however, the only way you can access that money is by selling the business. This means you need to be prepared to wait two to five years before you earn back your liquid cash investment.
- Do you have that much saved? Most people don’t use cash as an option because they don’t have that much cash or value in stocks and bonds to risk in an investment of an online business.
2. SBA Loans
During the great recession, suggesting you would buy an online business with an SBA loan was a great way to ensure no one responded to your requests. But SBA loans are becoming increasingly more prevalent.
- Let the business pay for itself. One of the greatest benefits of an SBA loan is that most loans only require a down payment of 10% – 20% of the purchase price.Let’s assume you buy a website that earns $100,000 per year and that you pay $300,000 for the business. Using an SBA loan, you’ll need to pay $30,000 – $60,000 at close while the rest of the payment is paid off over 10 years.This means the business will actually pay for itself out of its own earnings, and you’ll earn back your original investment in less than a year.
- You are responsible for the loan. While getting an SBA loan significantly increases your purchasing power, you also take on the risk for that loan. This means you take on much more risk, and not everyone is comfortable taking on such a large loan that is dependent on the business remaining profitable for the foreseeable future.
3. Partner with an Investor
One of the more common arrangements we see among buyers are partnerships with an investor. There are many professionals who spent their careers in more ‘traditional’ business, who love the idea of the online business world, but don’t have the knowledge to venture out on their own.
- Access to significant capital. The benefit of this approach is obviously that you can access potentially large amounts of capital without risking your own personal equity (or at least not all of it). This allows you to buy more established, more profitable businesses. Why is this important? If you make a small, incremental improvement of 5% on a large business, that results in more real dollars returned than if you make a 5% improvement on a small business.
- You are tied to the investor. The downside is obvious: you will be tied to your investor. If they have trouble being ‘hands-off’, you’ll need to answer questions about what you are doing, how the business is performing, and what they should expect. In addition, as long as they have equity in the business, you’ll be paying them profits from your work.
4. Home Equity Line of Credit
Using equity built up in your home is an easy and natural source to access funds to buy an online business.
- Little restrictions, and low-interest. Interest rates on home equity are still extremely low, and the funds that you get from your home equity line of credit can be used in many different ways. Business loans often come with a number of restrictions that home equity loans lack.
- Somewhat predictable. Accessing your home equity is much more predictable than applying for an SBA loan. If you have equity built up in your home, you are likely very aware of what you will be able to borrow. This makes it easier to approach sellers since the funds are somewhat certain.
- Do you want to risk your home? But the downsides to this funding option need to be considered: closing costs can be high, making the out-of-pocket expenses difficult to swallow, there may be tax consequences which make this less desirable, and of course, you are risking your home in the event of a default on the loan.
5. Roll Over for Business Startup (ROBS)
This option is a fairly obscure, yet attractive funding option to acquire a business. Using ROBS, you can tap into your retirement funds and use those funds to buy an online business without paying the tax penalty for withdrawing funds early from retirement.
- Access tax-free funds. The biggest advantage to using ROBS is that you can access funds that are held within a tax shelter (and presumably won’t be using for anything else until retirement) to acquire an online business, and you can keep those funds in that tax shelter.
- Similar to dealing in cash. For the person selling their business, using ROBS appears very similar to someone buying their website with cash. Accessing the funds in your retirement account only takes a few weeks and, once accessed, are easily transferable to the seller without any work on their side.
- Options for your investment. Using ROBS, you can either treat your invested capital from retirement as an investment and grow your retirement portfolio in its tax-deferred shelter or you can convert out of the ROBS and benefit from any increase in the value of the business.
- More complex setup. Setting up a ROBS requires that you setup your company in the right way, otherwise you’ll risk having the IRS rule that you accessed your retirement funds in the wrong way, resulting in heavy penalties and back taxes.
- Must use a C-Corp. One of the requirements is that your business be established as a c-corporation. While you can transition out of this formation at a later date, most Internet businesses won’t benefit from a c-corporation structure.
- You risk your retirement. What happens if you buy a web business using your retirement account, but the business quickly fails? You lose your retirement.
6. Setup a Self-Directed IRA
Similar to using a ROBS account to buy a business, you can set up a self-directed IRA and use the funds to invest in an online business. But there is a significant restriction: you’ll need an investor to make the investment. The IRS has strict rules about self-dealing with a self-directed IRA, and one of those rules is that you can’t buy a business that pays you a salary with retirement funds (unless you want to use ROBS).
- Similar benefits to ROBS. Like ROBS, using a self-directed IRA allows you to access funds that otherwise are protected until retirement without taking on the tax consequences of withdrawing those funds early. It’s a great way to use an asset that otherwise would sit in the stock market growing 7% to 10% per year.
- Great for silent investors. This is a great option for a silent investor as it allows them to tap a portion of their overall assets that they may think are not accessible.
- You need an investor. You can’t use your own retirement account to make this investment unless you use a roll over for business startup, so you’ll need to find an investor who is ready to take the risk with you (and stay silent).
7. Borrow on Life Insurance
Finally, many people don’t know that you can actually take a loan out of your life insurance, assuming it is whole life insurance. As you pay into whole life insurance, you build up its “cash surrender value“, and amount of money that you can easily access.
- Easy access and friendly money. Generally speaking, accessing funds out of a whole life insurance plan is easy to do, and there typically isn’t a strict repayment plan. You’ll incur some interest, but this is often offset by the interest a whole life plan provides.
- How much is there? The problem with borrowing against a life insurance policy is that most people don’t build up significant “cash surrender value” until they are older. As a result, you may find that the amount of cash available is less than you need to complete a transaction. But using your cash surrender value can be a useful component of piecing together a financing plan.
8. Owner Financing a Deal
Strategizing how you can raise funds to acquire an online business is often like putting together a puzzle. One key piece to this puzzle may be to ask the person selling their website to finance a portion of the deal.
- A sign of good faith. When a seller is willing to extend a personal note on the business, that shows a strong sense of confidence in both the business and in their estimation of your ability to continue the business’s profitability.
- Friendly rates. Because the loan is negotiated between you and the seller, you can usually negotiate simple, straightforward rates and repayment rules. This usually works in your favor.
- Sellers hate owner financing. Don’t expect the person selling their website to be excited about accepting owner financing. Most sellers will resist any owner financing since it delays the benefit they get from selling their business. And even though the loan is secured against the website, they are selling the website for a reason: they don’t want it anymore. They won’t want to take it back if you’ve run the business into the ground.
Owner financing won’t be available for every deal, and when it is available, you should expect only 10% – 20% of the deal to be wrapped up in owner financing.
There are a number of ways you can finance the acquisition of an online business, even if you don’t have the cash reserves for an acquisition. How you finance the business depends a lot on your personal assets, your creativity, and your willingness to take on risk.
Yes, buying any business is risky. Make sure you know the consequences you’ll face if you make an investment that fails.
But don’t fall into the trap of thinking you need to have the cash on hand to buy a business. There are a lot of options available.
Featured Image: Pixabay modified by author for Search Engine Journal