Navigating a business acquisition loan

You’ve found the acquisition target, negotiated a price, and are standing on the edge of a pivotal moment in your business’s story. But, before pen meets paper and contracts are signed, every business leader must make sure they have the financial backing not only to cover the acquisition costs, but also to keep operations running smoothly post-ownership transfer.

Growth through acquisition, as it’s commonly referred to, offers a faster route to market share, established customer bases, and proven revenue streams. It’s become more common lately, as the Baby Boomer generation leaves the workforce, leaving behind profitable companies that the family has no interest in taking over. 

However, as you can assume, such a significant undertaking requires a large capital investment. Business acquisition loans and specialized acquisition financing come up as powerful, external resources in these moments, providing the necessary funding to turn an acquisition opportunity into record-breaking growth.

At its core, an acquisition loan is a specific type of financing designed to fund the purchase price of an existing business or its assets. It differs from a general business loan in its explicit purpose: facilitating the change of ownership for a target company. That distinction changes a few things, from where you get the loan to how you get the best approval for one.

Our article provides detailed information on the various financing options available, shedding light on the processes and requirements that you might not know are involved in securing the capital needed to acquire a business.

Understanding acquisition financing: How it works

Acquisition financing generally refers to the capital raised by a buyer to fund the acquisition of an existing company. The capital mix can involve various forms of debt or equity, each with its own structure, interest rates, and repayment terms. A lender provides funds to the buyer, who uses these funds to complete the acquisition transaction. 

Unlike a typical business loan, which relies heavily on the borrower's business assets and future projections, acquisition funding for an existing business considers the historical cash flow and asset base of the target company itself. In short, your company’s financials are considered in eligibility, but so are the financials of the company you’re targeting.

Why? Lenders will assess the financial health, profitability, and growth potential of the business being acquired, as its future cash flow will largely dictate the ability to service the new debt. This thorough examination, known as due diligence, is a key step where both the buyer and lender scrutinize the target company's financials, operations, and legal standing.

The primary purpose of an acquisition loan is to bridge the gap between the buyer's available capital and the purchase price of the business. This often includes not only the cost of the business itself but also working capital for post-acquisition operations or immediate improvements.

Types of business acquisition loans and financing options

The landscape of acquisition financing is diverse, offering several avenues for business owners seeking to fund a purchase. The best option for you will depend on the size of the acquisition, the financial strength of both your company and the target company, and the willingness of all parties to utilize different forms of collateral or share equity.

Traditional bank loans and term loans

For strong, well-established acquirers and financially strong target companies, a bank loan or term loan from a traditional bank can be a strong option. These are typically straightforward loans with a fixed or variable interest rate and a set repayment schedule over a specific term.

• Characteristics: Often require substantial collateral, which can range from the assets of the acquired business, the buyer's personal assets, or a combination. Lenders will scrutinize the buyer's credit score and financial history, as well as the target company's cash flow and profitability.
• Pros: Generally lower interest rates compared to more specialized or higher-risk financing options.
• Cons: Can be difficult to secure without significant collateral and a proven track record. May require a higher down payment.

Small business administration (SBA) loans

The Small Business Administration (SBA) offers several loan options designed for business acquisitions. The government-backed nature of these loans reduce risk for lenders, making it easier for them to approve loans to small businesses that might not qualify for conventional bank loan financing.

• SBA 7(a) Loan Program: This is the most flexible and common SBA program used for business acquisition. It offers flexible loan amounts and longer repayment terms than many conventional loans. A key benefit is the reduced down payment requirement, often as low as 10-25% of the purchase price. SBA 7(a) loan funds can be used for various purposes, including real estate, equipment, working capital, and business acquisition.
• SBA 504 Loan Program: Primarily designed for financing major fixed assets, such as real estate or machinery. It can be used for acquisition of a company’s assets, should the purchase price largely consist of these types of assets. This program typically involves a combination of a conventional bank loan (50%), a certified development company (CDC) loan (40%), and an equity contribution from the borrower (10%).

SBA loans are a popular choice for acquisition funding because they often come with more favorable terms than traditional loans, including lower interest rates and longer loan terms, which can improve cash flow for the newly acquired business. While the government guarantees a portion of the loan, the actual lender is a bank or credit union.

Asset-based lending (ABL)

Asset-based lending allows businesses to borrow against their existing assets. In the context of an acquisition, this means leveraging the assets of the target company, such as accounts receivable, inventory, or equipment financing.

• How it works: The loan amount is determined by a percentage of the value of eligible assets. As assets fluctuate (e.g., receivables are collected), the available credit line may change.
• Best for: Businesses with significant tangible assets but potentially inconsistent cash flow or a weaker balance sheet. This can be a flexible financing option for certain types of acquisition.

Seller financing

Also known as an owner carry or seller carry-back loan, seller financing occurs when the current business owner agrees to directly finance a portion of the purchase price for the buyer.

• Benefits: Reduces the upfront down payment required from the buyer and can signify the seller's confidence in the business's future. It also makes the transaction more attractive to lenders, as the seller has a vested interest in the buyer's success and repayment ability.
• Structure: Often structured as a “promissory note,” with specific interest rates and repayment terms negotiated between the buyer and seller. It's frequently used in conjunction with other financing options, such as an SBA loan or a conventional bank loan.

Leveraged buyout (LBO) financing

A Leveraged Buyout (LBO) is a specific type of acquisition where a significant amount of borrowed money (debt) is used to fund the purchase price of a company. The assets of the company being acquired are often used as collateral for the borrowed capital, and the cash flow generated by the acquired company is expected to cover the interest payments and repay the principal of the loan.

• Difference from general acquisition financing: While LBO financing is a form of acquisition financing, it is specifically characterized by the high-risk, high-reward strategy of using a disproportionately high amount of debt relative to equity to finance the deal. All LBOs are acquisitions, but not all acquisitions are LBOs. The term "leveraged finance" is often synonymous with LBO financing, referring simply to the use of substantial debt in a transaction.
• Focus: The success of an LBO hinges heavily on the acquired company's ability to generate strong, predictable cash flow to service the substantial debt burden.

Equity financing

While not a loan, equity financing is a common financing option for acquisitions. For you, this involves selling a portion of ownership in either your company or the target company to investors in exchange for capital.

• Sources: Can come from angel investors, venture capitalists, private equity firms, or even individual investors.
• Difference from acquisition loans: Unlike debt, equity financing does not require repayment of principal or regular interest payments. However, it means diluting ownership and sharing future profits with investors. The difference between equity and acquisition is that equity is a method of financing, which can be applied to fund an acquisition, whereas acquisition refers to the act of buying a business.

Qualifying for a business acquisition loan

Securing a business acquisition loan can be a complex process for some, often perceived as hard to get due to the layered risk assessment involved. This mindset comes from the more involved process, compared to traditional loans.

Lenders need to evaluate not just the borrower's creditworthiness but also the financial viability and future potential of the target company. However, with thorough preparation on your end, the process can be simplified and accelerated.

Key requirements for borrowers

To qualify for an acquisition loan, prospective acquirers must demonstrate both personal and financial readiness:

• Credit Score and Financial History: A strong business and personal credit score (typically 680 or higher) is crucial, especially for Small Business acquisition loans. Lenders will review personal financial statements, tax returns, and any existing personal debt.
• Industry Experience: Lenders prefer borrowers who have relevant experience in the industry of the target company because this shows an understanding of the business and its potential operational challenges.
• Robust Business Plan: A well-developed business plan is non-negotiable. It must clearly outline how the combined entity will operate, grow, and most importantly, generate sufficient cash flow to cover the loan repayment in addition to operating expenses. This plan should include detailed financial projections and a strategy for post-acquisition integration.
• Personal Collateral: Depending on the loan type and lender, personal assets (like real estate) may be required as additional collateral, particularly for Small Business acquisition loans where the borrower's personal guarantee is standard.

Requirements for the target business

The business being acquired also undergoes rigorous scrutiny by lenders:

• Financial Health and Stability: Lenders will analyze several years of financial statements (profit and loss, balance sheets, cash flow statements) to assess profitability, revenue trends, and the ability to generate sufficient cash flow to service the new debt.
• Profitability and Growth Potential: The target company should ideally have a history of consistent profitability and demonstrate clear potential for future growth.
• Valuation: The purchase price must be justified by a fair market valuation of the business. An independent valuation often provides credibility to the transaction.

The role of a down payment

A common question is, "Do you need a down payment for a business acquisition loan?" The answer is almost universally yes. While the exact percentage varies significantly by loan type and lender, a down payment is nearly always required.

• Typical Percentages: For SBA 7(a) loans, a down payment of 10-25% is common. Conventional bank loans might require 20-30% or more.
• Impact: A larger down payment reduces the lender's risk, potentially leading to more favorable interest rates or terms. It also demonstrates the buyer's commitment and financial stake in the acquisition. In some cases, seller financing can contribute towards the buyer's equity injection, reducing the personal cash outlay.

Assessing difficulty: Are business acquisition loans hard to get?

The perception of difficulty in obtaining a business acquisition loan stems from several factors. Unlike a simple personal loan, these loans involve assessing two entities: the borrower and the target company. This means a higher degree of due diligence and a more complex underwriting process for the lender.

Factors that can make them challenging:

• Complexity of the Transaction: Acquisitions involve detailed legal, financial, and operational aspects.
• Risk Assessment: Lenders view acquisition loans as inherently high-risk because they rely on the future performance of the newly combined entity.
• High Loan Amounts: The loan amounts can be substantial, increasing the lender's exposure.

However, improving your chances involves:

• Strong financials for both buyer and target.
• A compelling business plan.
• Expert advisors (brokers, accountants, attorneys).
• Realistic valuation and purchase price.

The business acquisition loan process: From application to funding

The process of securing acquisition financing requires careful planning and execution. While timelines can vary, understanding each stage can help borrowers navigate the path more efficiently. The answer to "How long does it take to acquire a loan?" depends heavily on your preparedness as the buyer and the complexity of the transaction, but typically ranges from 60 to 120 days or more from initial application to funding.

A. Preparation and due diligence

Before approaching lenders, it’s worth your while to prepare. This initial step can significantly influence the success and speed of the loan approval.

• Thorough Research of the Target Company: Go beyond surface-level information. Understand its market position, competitive landscape, customer base, and operational efficiencies.
• Developing a Robust Business Plan and Financial Projections: This document is your roadmap and a cornerstone for any lender. It should detail your vision for the acquired business, how you plan to manage it, how it will generate the necessary cash flow for repayment, and realistic financial forecasts.
• Assembling Necessary Financial Documents: Gather personal financial statements, tax returns (for both individual and any existing businesses), and comprehensive financial records for the target company (e.g., P&L statements, balance sheets, cash flow statements for the past 3-5 years).

B. Finding the right lender

Not all lenders specialize in business acquisition loans. Identifying the right partner is crucial.

• Private Lenders: Private lenders offer various small business loans, some of which cater to acquisition. These can sometimes offer faster approval times but may have higher interest rates.
• Specialized Acquisition Funding Providers: Some financial firms focus exclusively on providing acquisition financing, including mezzanine debt and Leveraged Buyout solutions, often for larger transactions.
• Banks and Credit Unions: Traditional financial institutions often offer SBA loans and conventional bank loan options. It's beneficial to seek out lenders with established business lending departments experienced in acquisition funding.
• Importance of Expertise: Choose a lender who understands the nuances of business acquisition and can provide valuable guidance through the process. Where is the best place to get a business acquisition loan is subjective and depends entirely on your specific circumstances, the size of the deal, and the type of business.

C. Application submission

Once a potential lender is identified, the formal application process begins. Here, you’ll submit a comprehensive package of documentation.

• Required Documentation: This typically includes your detailed business plan, personal and business financial statements, tax returns, legal documents related to the transaction (e.g., Letter of Intent, purchase agreement), and any requested third-party valuations or appraisals of the target company.

D. Underwriting and approval

This is the most intensive phase, where the lender meticulously evaluates the risk of the loan. The underwriting team will carefully consider all submitted documents.

• Lender's Assessment: They will analyze the financial health of both the borrower and the target company, assessing the strength of the business plan, the value of any collateral, and most importantly, the projected cash flow to ensure the debt can be serviced.
• Additional Information Requests: Be prepared for follow-up questions and requests for additional documentation as the lender performs their due diligence.
• Timeframe Considerations: This phase can be lengthy, ranging from several weeks to a few months, depending on the complexity of the deal and the lender's pipeline.

E. Closing the loan

Upon approval, the final stage involves legal documentation and fund disbursement.

• Reviewing Terms: Carefully review all loan terms, including interest rates, repayment schedule, loan amounts, and any covenants, before signing.
• Signing Documents: Both the borrower and lender will sign the formal loan agreements.
• Funds Disbursement: Once all conditions are met, the loan funds are disbursed, allowing the buyer to complete the purchasing transaction of the business.

Strategic considerations for acquisition financing

Securing an acquisition loan is a significant step, but don’t forget that the transaction itself is merely the beginning. Thinking beyond the funding itself can enhance the likelihood of post-acquisition success.

Cash flow is king

Throughout the entire process, lenders prioritize one thing above all else: the ability of the acquired business to generate consistent and sufficient cash flow. This cash flow is the primary source for loan repayment. Even if a business has strong assets, if its cash flow is insufficient or unpredictable, securing financing will be challenging. Your business plan must demonstrate clear, realistic cash flow projections that assure the lender of your ability to meet financial obligations.

Risk assessment

Acquisition inherently involves a degree of high risk. Lenders mitigate this through stringent due diligence, requiring collateral, and often demanding personal guarantees. As a buyer, understanding these risks and having contingency plans in place can help demonstrate your preparedness and increase lender confidence. Identifying potential pitfalls early in the due diligence phase can prevent major issues post-acquisition.

Post-acquisition integration

While not directly about financing, the lender will want to see a credible plan for integrating the acquired business. How will you merge operations, retain key staff, combine customer bases, and realize the synergies you envisioned? A well-thought-out post-acquisition strategy reinforces the viability of your business plan and your capacity to maintain or grow cash flow.

Professional advisors

Navigating the complexities of business acquisition and its financing requires expertise. Engaging legal counsel, an experienced accountant, and a business broker or acquisition consultant can be invaluable. These professionals can help with due diligence, business valuation, structuring the transaction, preparing financial documents, and identifying suitable financing options. Their expertise can save time, money, and mitigate potential pitfalls, making the entire process smoother and more successful.

Empowering your business growth through strategic acquisition

Business acquisition loans and the broader spectrum of acquisition financing solutions are powerful tools that enable aspiring business owners and established companies to achieve strategic growth through the purchase of existing enterprises. From traditional bank loans and flexible SBA loans to specialized Leveraged Buyout structures and seller financing, numerous avenues exist to secure the funding to move forward.

The key to successful acquisition funding lies in diligent preparation, a deep understanding of the target company's financial health, a robust business plan demonstrating strong cash flow projections, and a clear understanding of the various financing options available. While the process requires effort and comprehensive due diligence, the rewards of a successful acquisition—expanded market reach, increased revenue, and diversified operations—can be substantial and transformative for your business journey. With the right strategy and financial partnership, your vision for growth through acquisition can become a reality. Apply for business financing through our streamlined digital application today.