How Business Acquisition Funding Works

Business acquisition financing must take into account what it will cost to run the business after the acquisition. Acquisition financing is a choice between debt, and or equity. The right business acquisition capital structure will make the transition smoother, and position the business for more growth.

During a business acquisition process, try and negotiate for a good financing structure. Aim for a smooth ownership transition, in order, to position your company to prosper in the years to come. Understand how each type of business acquisition financing works, and find the right mix.

A proper structured acquisition financing package will provide you with the flexibility to integrate your acquisition and support your company’s future growth. 

 

What is the value of the business acquisition?

Before arranging financing to acquire a business, you need to determine how much the business you want to purchase is worth. The value of a business or company should depend on its profitability as measured by earnings before interest, taxes, depreciation and amortization (EBITDA).

EBITDA should exclude non-recurring expenses, or revenue to accurately represent the future earnings potential of the business. A business acquisition price is as a result of agreeing to a multiple of the company’s normalized EBITDA. This reflects the dependability of its profits, and growth prospects.  


Ways to fund a business acquisition

Let’s take a look at several ways and how to fund a business acquisition.

Loan against business assets

Taking an asset-backed loan is using the value generated by the target company to acquire it. An asset-backed loan amount depends on the liquidation value of assets of the target business.

You are getting financing on the value of the business’s assets, not liabilities. This is a risky strategy for funding a business acquisition. 

A lender willing to finance the acquisition at a price meeting the seller’s valuation of their own business asset value, is hard to find.

A lender in an acquisition deal will provide a loan against the assets of the business. 

The lender will have a first charge against assets such as accounts receivable, inventory, real estate and equipment in a recovery situation. 

asset backed loans
leveraged buyout


Leveraged buyout

Leveraged buyouts allow the buyer to commit very little of their own capital, and use debt on the assets of the business being bought. A leveraged buyout is a high-risk, high-reward strategy.

It has a huge payoff if you manage to pull it off, but it can quickly ruin businesses. Leveraged buyouts allow buyers to maximize their returns by minimizing the cash they invest in the acquisition.

While leveraging assets can increase returns, it can also maximize your losses, and have a large negative impact on your rate of return.

You leverage some assets of the business, such as equipment, real estate, or inventory, to help finance the acquisition. 

It is a way to finance a business acquisition with no money down, by simply leveraging the assets of the business.  

Bank Loan

Most banks have specific provisions put aside for business acquisitions. Getting a loan from a commercial bank to finance the acquisition of a business can be difficult.

Banks lend funds against existing assets not business plans. To get a loan, you must have substantial assets, good personal credit, and a solid track record in the industry.

A bank may approve financing if the company to be acquired has a growing stream of revenues, EBITDA, and valuable assets for collateral. 

Securing bank approval can be problematic when attempting to fund an acquisition that largely has receivables and less cash flow. 


bank loan
sba loan

SBA Loan

SBA loans will cover 75% of the value of acquisition between $150,000 and $5 million. The interest rate available is also competitive, at around 8 to 10% for loans of over $50,000.

The repayment can be made over a period of seven to ten years. A well-planned business acquisition should cover the loan interest expenses, allowing your business to benefit from the extra cash flow in the short-term.

Small Business Administration (SBA) loans are also a good option for entrepreneurs looking to acquire a small business. Because they are government guaranteed, SBA loans are best for small business owners who may not qualify for a traditional bank loans.

Borrowers using a 7A loan can get up to $5M to cover most of the cost of the business purchase. Down payment may be as low as 10% for acquisitions.

A borrower must meet the SBA’s requirements including limits on net worth, average net income, and overall loan size.

SBA also requires details on accounts receivable, personal as well as business tax information, and personal and business financial statements. 

An applicant for SBA 7(a) financing for an acquisition may also need to supply their corporate charter.

To qualify, potential borrowers must:

  • Have good credit score
  • Have a 10% down payment
  • Provide personal financial details
  • Provide 3 years of tax filing details
  • Prove industry experience in the target business acquisition 



Issuing Bonds

Issuing bonds is a great option to fund a business acquisition. A company may issue bonds, as a means of financing an acquisition. 

Selling bonds on the open market is advantageous over seeking funding from a bank or private lender.

Bond issue terms are more complicated than an SBA or bank loan. The terms are set out in a private placement memorandum before being distributed to relevant investors.

You can set the coupon rate of the bond, but you should be realistic. Bond markets are an alternative source of financing for mergers and business acquisitions. 


bonds
mezzanine financing

Mezzanine financing

A mezzanine finance is used to cover any deficit left between the buying price and financing from the other sources. Mezzanine financing carries a higher interest rate with flexible repayment terms.

This is a good acquisition financing option for companies interested in a financing solution that is tailored for their specific situation.

Mezzanine lenders provide funding based on a multiple of a company’s EBITDA. It offers most or all of the business acquisition funding to close a deal. 

Mezzanine financing eliminates the need for an equity investor.  


Seller Financing

Owner financing involves the buyer making a down payment to the seller. The seller agrees to finance the rest of the transaction or a portion of it.

The buyer will then make installment payments to the seller as per the agreed terms. Seller financing may be a good way to expedite the sale of a business.

It also allows the seller to receive a steady stream of regular payments from the buyer. When structured correctly, it could provide more income than traditional fixed-income investments.

A business acquisition buyer benefits from reduced costs and more flexible terms when dealing directly with the seller. 

The seller provides you with a loan that is amortized over a period of time. You pay back the loan from the proceeds of the business.

Owner financing is easier to get and more flexible than conventional financing. It gives the seller a vested interest in disclosing accurate performance information, and is cheaper.

Sellers are usually willing to finance 30% to 60% of the agreed-upon sale price. Unless you are a strong buyer with substantial assets, and a large down-payment.

Seller financing is available only after the seller has done their due diligence on you. The seller will want to see your credit, assets, experience, and business plan. 


seller financing
business equity

Business Equity

Offering equity to the owners of a business acquisition can be an excellent way of acquiring a new business. This is recommended in cases where the owners are interested in maintaining some control in the business.

In the case of a merger, it would involve offering an equity stake in the newly merged business. The equity share offered will be based on a valuation of the new firm by an objective third-party.

Alternatively, when both businesses remain separate entities under a holding company, the equity share will be based on a valuation of the acquired business.

This acquisition funding option is good since you will pay less cash and still retain some of the seller’s expertise and insight. You can buy the assets of the business without any of the bad liabilities.

If you buy the stock, you get all the assets, liabilities, and risks. Most business acquisitions involve the transfer of some assets and liabilities including existing business debt. 

This process can get complicated, and you may need the approval of the creditors before assuming the debt. 


Third-Party Financing

These are private equity firms and their provision of funds will involve them acquiring some shares of the newly formed business. 

Third-party financiers are usually involved in making some management decisions.

This allows you to tap into a new network of experienced industry professionals that can generate significant value through your new business acquisition. 


third party financing
personal funds

Personal Funds

The simplest way to finance a business acquisition is to use your own money. These funds include your savings, retirement accounts, and home equity.

You will need to use some of your funds for the business acquisition. Most buyers use their money in addition to seller financing, and a business loan. This leverage allows them to acquire large businesses. 


Joint Venture

To buy an acquisition through a joint venture with another company can be a great way to have joint control of a new business.

However, it is a challenge to find a suitable JV partner. Most joint ventures destroy value, and making management decisions at the acquired business may prove hard depending on your equity stake.

In case two businesses can find the right working relationship, the combined expertise provided by two sets of managements can generate considerable value. 


joint venture
earn out

Earn out 

This works best where the seller is already considering an exit and is relatively flexible on payment terms. Most of the transaction fees that you pay are contingent on the company’s ongoing success.

For instance, you could pay 30% of the business acquisition’s value upfront. Then pay 20% of its revenues in each of the first 5 years after the acquisition depending on triggers and clauses.

A business owner looking to sell while the business is profitable, can benefit from the medium-term revenues in the short term.  


In conclusion;

Purchasing a business can be incredibly rewarding and lucrative. Getting business acquisition financing can be difficult without an established business, or a track record of success in the same industry.

If you are acquiring a business or a franchise, lenders want to ensure you are investing in a viable company. When acquiring an existing business, you need to see records of the business’s financial performance, valuation and projections.

Your related industry experience in running a similar business, will also help. Lenders and investors want to see that you can successfully manage and grow the new acquisition.

Remember that getting financing usually increases your closing costs. The amount you need to budget for closing costs will vary based on the size and type of business you are looking to buy.

Budgeting at least 10% of the buying price for closing costs is a good idea. When seeking business acquisition financing, you can apply for loans through traditional banks and private lenders that specialize in this market.

Private lenders may offer loans to companies that do not meet banking requirements. Funding from private lenders has much higher interest rates and fees compared to bank financing.

Acquiring a business is only half the battle. You still need to make sure that you have enough funds to operate the business profitably. If you need additional funding for running the business, negotiate it when you are negotiating the acquisition. Trying to get funding immediately after a business acquisition is hard.  

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