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Pitfalls Of Buying A Business With No Money Down: A Risky Endeavor

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Jeff Snell | 04/02/2024

Acquiring a business with no money down might sound like a dream come true for aspiring entrepreneurs looking to jumpstart their journey into ownership without the burden of upfront capital. However, beneath the allure lies a plethora of risks and pitfalls that could potentially jeopardize the financial health and stability of both the buyer and the seller. From increased debt service to heightened default risks, the decision to pursue a zero-money-down acquisition warrants careful consideration and evaluation of its potential consequences.

First, let’s consider what a seller willing to engage in a no-money-down transaction represents by first detailing what a seller of a quality business actually looks like. Sellers of quality businesses have spent years, if not decades, building their brand, customer base, talented employees, and vendor relationships. Why would they literally give that valuable asset away to someone unwilling or unable to invest (usually just 10%) of their own money? The answer is they don’t. In 20+ years of successful business brokering, I have never – not once – recommended a seller participate in a no-money-down transaction. There’s no need to. A quality business properly prepared and marketed will attract financially qualified quality buyers.

If you are in the market to buy a business, you don’t want a seller willing to engage in a no-money-down transaction. This almost guarantees that they are dumping a toxic asset that you will regret down the road.

One of the most significant drawbacks of purchasing a business with no money down is the increase in debt service for the buyer. Without any initial investment or equity stake in the business, the entire purchase price must be financed through loans, resulting in higher monthly payments and an increased financial burden. This elevated debt service not only strains the buyer's cash flow but also leaves little room for maneuvering in case of unforeseen expenses or economic downturns.

Moreover, relying solely on borrowed funds to finance the acquisition incurs higher interest costs over the long term. Traditional lenders and financial institutions often charge higher interest rates for loans with minimal or no down payment, reflecting the increased risk associated with such transactions. As a result, the buyer ends up paying significantly more in interest over the life of the loan, further impacting the profitability and sustainability of the acquired business.

Another critical factor to consider is the impact on the debt service coverage ratio (DSCR), a key metric used by lenders to assess the borrower's ability to service debt obligations. Purchasing a business with no money down often leads to a precarious DSCR, as the buyer's cash flow may not be sufficient to cover the increased debt service payments in the event of a downturn. This places undue pressure on the business's profitability and cash flow generation increasing the likelihood of default.

Low DSCR can also raise concerns among lenders about the buyer's ability to repay the loan which could result in the note being called by the lender.

Zero-money-down acquisitions pose significant risks to both lenders and the Small Business Administration (SBA) in terms of default. Lenders face heightened exposure to default risk due to the absence of borrower equity, making it more challenging to recover their investment in the event of business failure or non-payment. Similarly, the SBA, which guarantees a portion of loans made to small businesses, faces an increased risk of a financial loss if borrowers default on loans obtained through its programs. This is why, even though technically permitted by SBA guidelines, no commercial lenders have approved transactions structured in this way to date.

When a seller agrees to provide financing in second position to the commercial lender (which is appropriate in many transactions), there are still inherent receivable risks involved. In the event of default or financial distress on the part of the buyer, the seller may struggle to recoup the outstanding balance owed, potentially resulting in significant financial losses and legal complications. Remember – second position is LAST position.

While the prospect of buying a business with no money down may seem enticing, it is essential for buyers to recognize the inherent risks and pitfalls associated with such transactions. From increased debt service and interest costs to heightened default risks and receivable challenges, the decision to pursue a zero-money-down acquisition requires careful consideration and thorough risk assessment. Ultimately, buyers should weigh the potential benefits against the substantial drawbacks and explore alternative financing options that offer a more balanced and sustainable approach to business ownership.

In closing, always remember that if it sounds too good to be true, it usually is. Don’t fall for the no-money-down pundits who make incredible claims while they line their pockets with dollars you could be putting towards a down payment on a quality business.


This blog was originally written by Jeff Snell, LMCBI, M&AMI, CM&AP, ABA. Jeff is the founder and principal broker of ENLIGN Business Brokers and Advisors (www.enlign.com) headquartered in Raleigh, NC. For 20 years, ENLIGN has been providing business brokerage and M&A transaction services to main street and lower middle market business owners across the United States. He can be contacted at (919) 624-1124 or jsnell@enlign.com.