This article is one of a series that offers insight and guidance into the process of buying selling or valuing a business. This particular article specifically addresses business acquisition and business acquisition loans. Whether you want to buy, sell, or appraise the valuation of a going-concern business, or identify financing, these articles provide specific guidance and references to help you accomplish your goal.
Financing the Business Acquisition
by Tom West
The epidemic of corporate
downsizing in the U.S. has made owning a business a more attractive
proposition than ever before. As increasing numbers of prospective
buyers embark on the process of becoming independent business owners,
many of them voice a common concern: how do I finance the acquisition?
Prospective buyers are aware that any credit crunch prevents the traditional lending institution from being the likely solution to their needs. Where then, can buyers turn for help with what is likely to be the largest single investment of their lives? There are a variety of financing sources for business acquisition loans, and buyers can find one that fills their particular requirements. (Small businesses--those priced under $100,000 to $150,000--will usually depend on seller financing as the chief source.) For many businesses, the following are the best routes to follow:
Buyer's Personal Equity
In most business acquisition situations, this
is the place to begin. Typically, anywhere from 20 to 50 percent
of cash needed to purchase a business comes from the buyer and his
or her family. Buyers should decide how much capital they are able
to risk, and the actual amount will vary, of course, depending on
the specific business and the terms of the sale. But, on average,
a buyer should be prepared to come up with something between $25,000
The dream of buying a business by means of a highly-leveraged
transaction (one requiring minimum cash) must remain a dream and
not a reality for most buyers. The exceptions are those buyers who
have special talents or skills sought after by investors, those
whose business will directly benefit jobs that are of local public
interest, or those whose businesses are expected to make unusually
One of the major reasons personal equity financing
is a good starting point is that buyers who invest their own capital
start the ball rolling--they are positively influencing other possible
investors or lenders to participate.
One of the simplest--and best--ways to finance the acquisition of a business is to work hand-in-hand with the seller. The seller is the best source for a business acquisition loan. The seller's willingness to participate will be influenced by his or her own requirements: tax considerations as well as cash needs.
In some instances, sellers are virtually forced
to finance the sale of their own business in order to keep the deal
from falling through. Many sellers, however, actively prefer to
do the financing themselves. Doing so not only can increase the
chances for a successful sale, but can also be helpful in obtaining
the best possible price.
The terms offered by sellers are usually more
flexible and more agreeable to the buyer than those from a third-party
lender. Sellers will typically finance 30 to 50 percent--or more--of
the selling price, with an interest rate below current bank rates
and with a far longer amortization. The terms will usually have
scheduled payments similar to conventional loans; the tax picture,
however, can be better than with straight debt.
As with buyer-equity financing, seller financing
can make the business more attractive and viable to other lenders.
In fact, sometimes outside lenders will refuse to participate unless
a large chunk of seller financing is already in place.
Venture capitalists have become more eager players
in the financing of independent businesses. Previously known for
going after the high-risk, high-profile brand-new business, they
are becoming increasingly interested in established, existing entities.
This is not to say that outside equity investors
are lining up outside the buyer's door, especially if the buyer
is counting on a single investor to take on this kind of risk. Professional
venture capitalists will be less daunted by risk; however, they
will likely want majority control and will expect to make at least
30 percent annual rate of return on their investment.
Small Business Administration
Thanks to the U.S. Small Business Administration
Loan Guarantee Program, favorable financing terms are available
to business buyers. Similar to the terms of typical seller financing,
SBA loans have long amortization periods (ten years), and up to
70 percent financing (more than usually available with the seller-financed
SBA loans are not, however, a given. The buyer
seeking the loan must prove stability of the business and must also
be prepared to offer collateral--machinery, equipment, or real estate.
In addition, there must be evidence of a healthy cash flow in order
to insure that loan payments can be made. In cases where there is
adequate cash flow but insufficient collateral, the buyer may have
to offer personal collateral, such as his or her house or other
Over the years, the SBA has become more in tune
with small business financing. It now has a Lo-Doc program for loans
under $100,000 that requires only a minimum of paperwork. Another
optimistic financing sign: more banks are now being approved as
Banks and other lending agencies provide unsecured
loans commensurate with the cash available for servicing the debt.
("Unsecured" is a misleading term, because banks and other
lenders of this type will aim to secure their loans if the collateral
exists.) Those seeking bank loans will have more success if they
have a large net worth, liquid assets, or a reliable source of income.
Unsecured loans are also easier to come by if the buyer is already
a favored customer or one qualifying for the SBA loan program.
When a bank participates in financing a business
sale, it will typically finance 50 to 75 percent of the real estate
value, 75 to 90 percent of new equipment value, or 50 percent of
inventory. The only intangible assets attractive to banks are accounts
receivable, which they will finance from 80 to 90 percent.
Although the terms may sound attractive, most
business buyers are unwise to look toward conventional lending institutions
to finance their acquisition. By some estimates, the rate of rejection
by banks for business acquisition loans can go higher than 80 percent.
With any of the acquisition financing options,
buyers must be open to creative solutions, and they must be willing
to take some risks. Whether the route finally chosen is personal,
seller, or third-party financing, the well-informed buyer can feel
confident that there is a solution to that big acquisition question.
Financing, in some form, does exist out there.
About the Author
||Mr. Tom West is the editor of The Business Broker, a monthly newsletter for the business brokerage field. He has written the The Business Reference and Pricing Guide and The Resource Handbook for Business Brokers. He is a founder, past president, and former executive director of the International Business Brokers Association (IBBA). He is a frequent lecturer and seminar leader on all aspects of buying, selling, or appraising a business. Mr. West is probably the most knowledgeable individual in the country today concerning the issues of buying or selling small to mid-sized businesses.