Guide To Acquisition Financing
When your business reaches its limits in terms of organic growth, you’ll need to find new ways to expand — such as acquiring another business. This will be one of the most significant financial investments you’ll ever make, and it can be daunting to figure out the best way to raise financing. But don’t worry — we’ve got you covered.
In this guide, we’ll walk you through the different types of business acquisition loans available and how to get one to buy a business. We’ll help you understand the ins and outs of the different loan options so that you can make an informed decision about the best loan for you.
- What is a business acquisition loan?
- The main business acquisition loan types
- Who can use a business acquisition loan?
- How to get a business acquisition loan
What is a business acquisition loan?
Let’s start by defining the topic. A business acquisition loan is a loan that is used to finance the purchase of an existing business. It can be a great way to help you grow your business, as it allows you to use the money to purchase the assets, personnel and other resources of the company you’re acquiring. With a business acquisition loan, you can get access to the capital you need to help you expand and reach your goals.
Acquisitions are a core part of the economy, with $2.9 trillion of M&A activity in the United States in 2021 alone. Most of these transactions are financed by banks and other lenders, who have developed specialized business acquisition loan products.
The type of acquisition financing available to you depends on several factors, including:
- The size of your current business
- The valuation of your acquisition target
- Your business plan
- Your credit rating or credit score
- Your available capital
You must also think about the terms of the loan and how that might impact your acquisition financing plan. Things to consider here include:
- Loan process: Many lenders can offer a quick application process, while others might need more time to consider
- Loan amount: Some business acquisition loans have minimum or maximum values
- Interest rates: Interest repayments can devour your cash flow, so affordability is a primary consideration
- Down payment: You may need to provide some of the acquisition financing yourself
- Term: Many business loans have a term of around 10 years, although this can vary between products
One common financing term is conspicuous by its absence here: collateral. That’s because acquisition loans are typically not secured with collateral as traditional loans are. Instead, they’re based on cash flow lending, which involves what’s called a collateral airball or financing gap — meaning assets are less than debt for purchase.
Who can use a business acquisition loan?
Business acquisition loans can be used by entrepreneurs or established companies who are looking to purchase an existing business or acquire a controlling interest in an existing business. These loans can also be used by individuals or companies who plan to merge two businesses.
Business acquisition loan types
Business acquisition loans can range from straightforward term loans to more complex arrangements involving equity. On Foro's Bank Loans Products page, you can learn more about which type of loan is right for your business. We’ve partnered with top financial institutions to provide you with access to a full range of commercial loan products, including the following:
A term loan is the most familiar form of lending. Your lending partner provides you with a lump sum, which you agree to repay with interest over a fixed period.
- May provide access to larger loan amounts (up to $100 million) than other options, assuming your business has the debt capacity to support it.
- Clear repayment structure
- Lenders compete to offer the term loan at the lowest interest rate
- Difficult to secure unless you have an excellent credit rating or strong cash flow
- Lenders require a security interest in your business, meaning you will risk some of your equity
- Repayment terms are usually strict, meaning businesses must be able to make payments on time or risk defaulting
SBA business acquisition loans
The federal Small Business Administration (SBA) operates a loan scheme that guarantees business-related borrowing of up to $5 million for business acquisitions and $10 million for real estate acquisitions. SBA loans often have favorable terms, too, including lower down payment requirements. The tradeoff? Required personal guarantees and personal guarantee fees, with no clear path to reducing or eliminating these personal guarantees over time.
- Down payments typically in the range of 5%-10%, depending on the situation
- Favorable interest rates
- Easier to obtain loan approval for an SBA loan as the lender has a repayment guarantee from the government
- Credit amount capped at $5 million for acquisition funding and $10 million for real estate acquisition
- SBA loans require personal guarantees from each person with 20% or more ownership in the company
This type of acquisition financing product works the same way as a term loan, but it is collateralized against a tangible asset, such as real estate, equipment and/or working capital. If your business acquisition includes equipment or property, you may be able to leverage those assets against the loan.
- Easier to obtain, as the loan is secured against a high-value asset
- Competitive interest rates
- Higher lending limits, typically up to $100 million
- Loan value can't exceed the value of your assets
- If the bank forecloses on an asset, you may lose a key piece of infrastructure
A business owner in need of capital has two main financing options: seek a loan or sell equity to investors. Mezzanine financing sits midway between these two levels of acquisition financing, hence the name.
Mezzanine financing is called a junior loan because it is typically subordinate to other forms of financing. This means that in the event of a default, the holders of mezzanine loans can only claim their share of the company’s assets after the senior lenders have been repaid. Because of this lower priority, mezzanine loans are generally considered riskier than other forms of financing, and as a result, tend to carry higher interest rates.
Mezzanine financing works best in conjunction with senior debt, providing an additional layer to the capital stack that can be used to bridge the gap between senior debt and equity.
- Access to capital when you don’t have available collateral (for example, when a bank is the senior lender on assets such as land, equipment and working capital)
- Retain control of equity in the short term
- You may be able to negotiate a loan on the strength of your business plan
- Interest rates are typically higher
- Lender may impose conditions on your business operations
- Risk of losing equity
With this type of acquisition financing, the owner rolls equity in the form of a seller note rather than paying cash equity into the deal. Owners take out a loan that sits on the business’s balance sheet and (like mezzanine financing) cannot be repaid prior to bank or senior debt. The benefit of seller financing is that it allows the owner more leverage with less cash.
- Loan agreement can be arranged between both parties without the need for an application process
- May incentivize the seller to complete the acquisition
- Seller has control of the terms of the loan
- Interest rate is often higher than commercially available rates
When should you consider a business acquisition loan?
Business acquisitions can make sense for any number of reasons. Here are a few scenarios in which you might apply for a business acquisition loan:
Scaling your business
Your long-term strategy can only go so far through organic growth. Every company reaches a point where they need to step up a level, and that usually means acquiring another business that's relevant to your core operations, such as:
- Companies with which you share synergies
- Strategic rivals
- Partner companies that want to sell
Acquisitions are also a way to establish your business in a new market. Rather than trying to build a new business from scratch, you can acquire an established company with a track record in that market. This can include companies in different:
- Product markets
- Demographic or audience markets
- Geographical markets, including international trade
Access to resources and assets
Some acquisitions are driven not by what the target business does but by what it owns. Buying out the target business gives you unlimited access to that business’s assets and resources, which can benefit your overall long-term strategy. Examples of this include:
- Taking ownership of a key supplier
- Acquiring valuable equipment or real estate
- Gaining access to intellectual property, such as trademarks and patents
Transfer of ownership
Not all acquisitions result in a merger with another business. In some cases, the acquisition is simply a transfer of ownership between two parties, which may still require acquisition financing. Common scenarios here include:
- Current owner stepping down — when a founder-owner retires, for example
- Leveraged employee stock ownership plans (ESOP)
How to get a business acquisition loan
When you approach a lender about a business acquisition loan, you will have to prove that the acquisition is a sound investment and that you can make your loan payments.
Here are five things you need to do:
Get an accurate business valuation of the target business
Some of the common ways to evaluate your acquisition target include:
- Current income: The company's financials can provide a valuation basis.
- Competitor analysis: If the business has been underperforming, you can compare it with how similar companies have performed in the same market.
- Asset evaluation: If you're mainly acquiring for access to equipment and property, you can base the evaluation on those assets.
Your acquisition target might be worth more in the future, but lenders generally want to focus on its current value based on the most recent 12 months. This will impact the total credit available to you.
Assess your financial situation
Lenders will also want to know if you're in a position to complete this acquisition. They will ask to see details including:
- Current financials: Detailed analysis of your existing business
- Other credit commitments: Any loans or open lines of credit
- Credit quality: The ability of your business to repay its debt obligations on time and in full
Lenders want to see that you can provide down payments and that you have enough cash flow to cover loan repayments in the event of a downturn.
Develop a business plan
Many lenders want to see how the acquisition supports your long-term profitability. In particular, they’ll want to know how long the acquisition will take to become profitable and how you'll respond if things don't go according to plan.
Make sure your business plan focuses on the fundamentals, such as cash flow, expenses and investment. Your financial statements and valuation of the target business should help you create a compelling business case for acquisition.
Obtain a Letter of Intent and draft purchase agreement
Many lenders will expect to see a Letter of Intent (LOI) signed by the owner of your acquisition. This confirms the essential terms of your deal, including the total price of the acquisition. It also confirms that the seller is interested in completing the deal. Banks will also require at least a draft purchase agreement (which codifies the terms outlined in the LOI) before underwriting and will certainly require the executed purchase agreement prior to or at closing.
An LOI may or may not be legally binding, depending on how it’s phrased. In all cases, it’s best to check with your legal team before submitting to ensure the LOI is accurate and fully outlines your commitments.
Look for an acquisition financing partner that can support your plans
There are over 4,200 commercial banks in the United States, each offering a range of business acquisition loan programs. There are also options other than traditional banks, including a new wave of fintechs (financial technology companies) that provide novel ways to find acquisition financing.
The good news is that you can look for a lending partner that offers competitive rates, flexible repayment terms and high lending limits. The less-good news is that finding the best deal is hard work and often involves working with a broker or advisor.
Another solution is to use an online service such as Foro. Foro uses artificial intelligence (AI) to build a detailed picture of your specific lending requirement. The AI engine can then match you to a lender in seconds, ensuring you never miss out on the best deal.
How do I qualify for a business acquisition loan?
Lenders want to help you grow, but they also want to protect themselves against defaults. Before approaching an acquisition financing partner, work with your finance team and other stakeholders to answer questions like:
- Do we have enough capital to cover down payments, initial investments and operational costs?
- Have we got a detailed plan for making this acquisition a success?
- Is this specific acquisition the best next step for our core strategy? Have we considered alternatives?
- What are the best, worst and mid-case financial scenarios? Can we meet our credit obligations if we experience a slowdown?
If you have convincing, data-driven answers to these questions, you should be able to find an acquisition financing partner to support you.
How do I buy a business with no money?
Most business acquisition loans require some form of capital injection on the buyer's part. Also, bear in mind you'll need capital for investment and operational expenses — look at Foro's loan product page for more financing options.
How hard is it to get a loan to buy a business?
A business acquisition loan is attainable for most companies with a solid credit profile and a robust business plan. If you have a strong, growing business, lenders will be glad to help you step up to the next level.
The trickiest part is finding the right lender. There are thousands of options out there, each with different interest rates, repayment terms and credit limits.
To improve your chances of finding the right deal, try using a lender-matching service like Foro. Set up your business profile in less than five minutes, and find lenders perfectly suited to your business needs.
About The Author: Ber Leary
Ber Leary worked in investment management for over ten years. He's now a full-time content marketing consultant specializing in finance technology and management strategy. Connect with Ber on LinkedIn.