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Financing the Business Acquisition

The epidemic of corporate downsizing and boom bust economies have 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 traditional lending institutions today do not lend to small businesses without tangible security or collateral to pledge. Where then, can buyers turn for help with what is likely to be the largest single investment of their lives? The good news is that, there are a number of financing sources, and buyers will find one that fills their particular requirements. For many buyers, here 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 put down as equity towards a purchase. The actual amount required will vary, of course, depending on the specific business and the terms of the sale. A general rule of thumb is you should come up with at least 25% of the purchase price.

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 large profits.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.

Seller Financing: 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’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 offered from a third-party lender. Sellers will typically finance 30 to 50 percent – or more – of the selling price, with an interest rate that is slightly higher or close to current bank rates and with a quick and simple process. The terms will usually have scheduled payments similar to conventional loans.

Since Seller financing can be a risk to the seller, often this loans can have a shorter repayment period and reporting requirement that will allow the Seller to monitor their risk safely. Seller's are careful in extending loans to a buyer and wants to ensure that the Buyer is qualified, has good credit standing and is able to operate the business successfully.

Venture Capital: Venture capitalists have become more eager players in the financing of large 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.

Canada Small Business Financing Program: Thanks to the Canadian government the Canadian Small Business Financing Program (CSBFP), favorable financing terms are available to business buyers. Similar to the terms of typical seller financing, CSBFP loans have long amortization periods (up to ten years - but typical of 5 years for business purchases), and up to 90 percent financing (more than usually available with the seller-financed sale and up to 50%).

CSBFP 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. Typical rates for this program are in the range of Prime + 3% with a 2% application fees.

Over the years, the CSBFP has become more in tune with small business financing. It now offer loans of up to $500,000. Another optimistic financing sign: more banks and lending institutions are now being approved as CSBFP lenders. For more information on the CSBFP program, visit the official CSBFP site by clicking the link here.

Lending Institutions: Banks and other lending agencies provide "unsecured" and "secured" 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 CSBFP loan program.

When a bank participates in financing a business sale, it will typically finance 50 to 75 percent of the real estate value, 50 to 75 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 65 to 75 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, a 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. Call VR Business Brokers today.

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