If you are a business owner who is pursuing an acquisition, there are certain things that you need to keep in mind, including:
- Growth opportunity offered by the target company
- Purchase price
- Financing terms
If these things do not align, there’s a chance that the acquisition will fail. One of the most common mistakes is to focus on the purchase price without considering the present and future growth plans of the target company. Two of the most challenging aspects of a business acquisition is securing the required capital and the most ideal financing terms.
Acquisition Financing Options
When it comes to business acquisition financing, there are several options available and each will have its own unique set of eligibility criteria, cost, expectations, terms, and covenants. These options are:
- Bank Financing
- Seller Financing
- Asset-based Financing
If the business you are trying to acquire has a lot of assets, a strong profit margin, and positive cash flow, you should be able to obtain traditional bank financing. On the other hand, if your goal is to acquire a service company with a lot of receivables and short-term assets, it can be harder to obtain traditional financing.
You can improve your chances of getting a loan by finding a lender that has historically financed the type of business you are trying to acquire. If the seller has a relationship with a financial institution, try talking to them. Also, you don’t have to accept rejection- just find another lender to discuss your options with. After all, different lenders use different qualification criteria.
For small- to middle-market transactions, the seller may be willing to finance a portion of the transaction. The easiest way to do this is for the buyer to make a down payment and the seller holds the promissory note for the balance of the purchase price. The business, as well as its assets, act as collateral.
The terms vary based on the specific agreement between the parties.
Recently, asset-based financing has increased in popularity as a viable funding source for business acquisitions. An asset-based loan is a revolving loan secured by the assets of the business. Typically, the loan is 65% to 80% of the value of the asset class.
The primary difference between traditional financing and asset-based financing is what the lender considers when underwriting the loan. In the case of traditional financing, the lender looks at the cash flow first and then the collateral value. On the other hand, in the case of an asset-based loan, the lender considers collateral, debt load, and quality of earnings.
The primary disadvantage of asset-based financing is the interest rates, which range between 12% to 28%.
Equity financing involves securing equity from sources such as angel investors, private equity firms, and venture capitalists in order to raise the capital to pay the seller as well as to put working capital into the business.
At this time, most private equity firms are looking for deals with $2+ million in earnings and $10+ million in revenues. However, the owner must be willing to give up 51%+ of the company. So, the buyer won’t have debt but will have to give up control of the company.
In addition, most of these firms are looking for a 25% minimum rate of return on their investment. While each has its own expectations and exit strategy, generally they hope to sell the business or take it public within a certain period of time.
Mezzanine financing is a combination of debt and equity, involving a variety of technical terms such as equity investment, senior/subordinated debt, and private-placement transactions.
In recent years, the size of the mezzanine industry has grown over the past year and is expected to continue to grow as we move into the future.
Ensure Your Deal is a Success
In order to ensure the best chances for success in any deal structure and the best terms, make sure that your offer and/or business plan is well structured. You should base your plan on the combined business- not just the current one. The plan should show how combining operations will improve collateral and cash flow, as well as increase growth. If you need more help with your business acquisition financing, contact Abundant Wealth Financial today.