What is a business acquisition loan?
A business acquisition loan is debt financing given to a company to fund a merger or business acquisition. The loans have restrictions including term limits, and interest payments. A lender often determines the loan amount advanced, and eligibility of the borrower.
15 ways to finance a business acquisition
Most lenders look for borrowers with strong potential for business acquisition success.
To increase your chances of loan approval, show your industry expertise, and any management know-how to the potential lender.
Lenders will likely expect the borrower to provide between 20 percent and 50 percent of the acquisition cost upfront.
They also prefer a smooth transition period. Consider keeping existing managers and seasoned employees after a business acquisition, to help with the transition process.
When seeking a business acquisition financing, consider some of these funding sources:
Private investors
If you do not have the enough capital to invest in the acquisition business, you can borrow from a private investor.
Most private investors make equity investments in businesses at the early stages.
Unlike with a loan, you don’t have to repay the amount to an investor. The investor becomes part owner of the business.
You can negotiate an agreement that gives you complete control of the business. The investor gains only a share of the business profits.
Seller financing
Ask the seller if they can offer financing for the acquisition. Sellers may provide a very reasonable interest rate.
This can also some lenders to invest in the business. The seller will finance the sale, and let you operate the business while you make payments to pay off the sale price.
You can always negotiate better terms with a seller. If you can finance part of the sale, you are more likely to get a seller to finance part of the deal.
Small Business Administration (SBA) loans
Small Business Administration (SBA) loans may provide a more lenient and flexible financing for qualified business acquisition borrowers.
SBA loans will cover 75% of the value of an acquisition between $150,000 and $5 million.
Repayment period can last over a period of 7 to 10 years.
A well-planned business acquisition should safely cover the loan interest expenses. This can also offer extra cash flow in the short-term.
Financial institutions (Bank loans)
Financial institutions offer loans to borrowers with a positive cash flow, solid management experience, industry expertise and a strong credit report.
It is important to cultivate and maintain a relationship with your lender. Be prepared and stay informed when seeking funding for an acquisition.
Most banks have specific provisions put aside for business acquisitions. The more cash flow you have as a combined business, the higher odds a bank with lend to you.
Banks will also need to be repaid within a couple years. Your own bank will often provide the best terms.
They need to like the industry, the management, the historical cash flow trends, the underlying assets of the business.
Company funds
If your company has plenty of cash, it may be possible to use 100% cash financing to acquire another business.
There are many acquisition financing options available. Most acquisitions involve some upfront cash payment.
This financing option can lower your own company’s liquidity. It is highly likely you will need some of that cash balance during the post-merger integration of the newly acquired business.
Companies are valued as a multiple of EBITDA. You may need to save up a few years of profits, to afford a business acquisition with no outside capital.
Company equity
Offering equity to the owners of an acquisition business can be an excellent way of smoothing the process.
If you have two equal sized businesses with the same valuation, you can merge the companies together.
Your original shareholders would own 50% of the new business. Equity share is offered based on a valuation of the new business by an objective third-party.
Sometimes you can implement a merger by using your equity as a currency. You can negotiate a pro rata stake in the combined business.
Earn out
This is one of the most creative ways to finance a business acquisition.
It works best where the seller is already considering an exit with relatively flexible payment terms.
Most of the transaction fees that you pay using this option are contingent on the company’s ongoing success.
Earn out allows the seller to benefit from the medium-term revenues in the short term.
Leveraged buyout
Leveraged Buyouts are not restricted to blue-chip companies. They allow the buyer to commit very little of their own capital.
You can use leverage on the assets of the business being bought. But, you should be able to generate enough cash flow to offset the debt from the cash flow generated by the new acquisition.
Leveraged buyouts are a high-risk, high-reward strategy. It has a huge payoff if you manage to pull it off. It can also sink businesses.
Asset-backed loan
An asset-backed loan uses the value generated by the target company to acquire it.
The loan is made on the basis that the assets of the target business can be liquidated in the worst-case scenario.
You will be getting funding based on the value of the acquisition’s assets. This is a risky option for financing a business acquisition.
It may be difficult to find a lender willing to finance the assets at a price that meets the seller’s valuation of their own business.
Asset-based lenders are allowed to sell your assets for less than they are worth without your agreement.
It is the most popular alternative to bank financing for funding a business acquisition.
The asset-based lender will make loan advances at rates from 70% to 90%.
The loan is against assets including receivables, inventory, plant & machinery and property.
Depending on the strength of the company’s asset base, it is a very effective method of business acquisition financing.
Issuing bonds
Issuing bonds is a good way to fund a business acquisition. Bond issuance terms are complicated.
The terms of the bond are set out in a company’s private placement memorandum before being distributed to relevant investors.
You should set a realistic coupon rate of the bond.
Third-party financing
Private equity firms provide funds for business acquisition for an equity stake in the new business.
Investment companies are more than willing to back good businesses building good ideas.
Before you reach out to private equity firms, make sure to research if they like to invest in acquisition deals within your industry.
Joint venture
Buying a business a joint venture can be an excellent way to gain joint control of a business.
This option has lower upfront costs. Where two businesses can find the right working harmony, the combined management expertise can generate more value for the acquisition.
Seller notes
The easiest way to finance an acquisition is to have the seller agree to not take all of their cash up front.
You can pay them 80% at closing, and pay 20% in a seller note in a year or two after the deal.
While a number of ways to structure such a deal exist, the most common method is to have the seller effectively grant the buyer a loan.
You then pay back the seller in monthly payments. The buyer and the seller will execute an actual note agreement between the two parties that define the payments, and the terms.
The seller note has financing terms such as a number of payments interest rate, and default provisions.
The terms protect both the buyer and the seller throughout the duration of the note.
It is common for a seller to finance 20 up to 100% of the purchase price using this method.
Personal assets
If you have enough money or credit, you can buy a new business. You can use your credit cards, retirement accounts, savings or a second mortgage to finance a business acquisition.
Using credit cards can lower your credit score. Risk what you can afford to lose when using personal assets.
Mezzanine financing
Mezzanine financing is debt that can be converted to equity in case of default. It is high risk and more expensive.
It is provided on an interest only basis with manageable repayments.
Mezzanine financing can be a useful way for a company to raise money for a business acquisition.
It offers an alternative to selling large amounts of equity outright.
Tips for a successful business acquisition
- Shared business goals and objectives
Do a lot of research and ask a lot of questions to identify areas that you may disagree on. Confirm that the business acquisition is in the best interests of both companies.
- Planning
- Liquidity
Entering into an acquisition could put both your business at risk and make the transaction unsustainable.
- Due diligence
Due diligence should detail the structure of the organization including; assets, audited financial statements, intellectual property, contracts, employee records and tax records.
- Culture of the acquisition business and integration
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Residential and housing developments
ground up construction
land acquisition
commercial real estate
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