15 Apr Acquisition Financing: Securing Funding from Cautious Lenders
For prospective buyers, price is frequently a first and foremost concern. While a low price may signal a great deal, it can also be a sign of a business that is already in decline and thereby not a strong, long-term investment opportunity. Unfortunately, in today’s market, as lenders continue to make borrowing more difficult, especially for new buyers, great deals—and perceived great deals—continue to be a huge draw. Rather than focus one’s energy exclusively on bargain hunting, however, prospective buyers are also encouraged to focus on finding ways to acquire the funding needed to enter the market. But how does one approach capital raising in today’s cautious lending climate?
Business Acquisition Loans
If you’re purchasing a business, even one that is currently under valued, the upfront costs are going to be high. Moreover, unless you happen to be the lucky recipient of a massive inheritance, chances are you are going to need to acquire financing to close the deal. This means that you are going to require a business acquisition loan. In short, a business acquisition loan is any loan acquired for the sole purpose of purchasing a business. Just like housing or student loans, business loans come with certain strings attached—in this case, they can only be used to purchase a business and not to purchase any other item or service.
Business acquisition loans are also notoriously difficult loans to acquire. Lenders are extra cautious when it comes to business loans and in many respects, this is no surprise. These are typically multi-million dollar loans so lenders do need to take additional precautions. So how does a new player—someone with limited cash flow and a limited business credit history—acquire the funds needed to close a deal on a business? While it may appear difficult and even impossible, armed with strong financials and the support of an experienced investment advisor, even new players can enter the market. The first step, however, is determining which loan is right for you.
Types of Business Acquisition Loans
Although there’s no loan type exclusively for business acquisitions, there are several small business loan products that are suitable for business purchases. These products fall into four primary categories: term loans, SBA(7)a loans, start up loans and equipment financing. Notably, while crowdfunding and other peer-to-peer lending options may come into play, in contrast to startups, in the case of purchases, crowdfunding and P2P lending are more likely to simply augment a primary source of funding.
Term Loan: A term loan is essentially like any other loan, including most personal loans. Buyers apply to a lender for a specific amount of funding. If they qualify, the terms are straightforward—they are expected to pay back the loan, in full, over a set period of time and usually at a fixed interest rate. Unlike a typical car or house loan, however, the amount of money and likelihood of rejection are both much higher. As a result, several lengthy applications may be required before finally securing a term loan.
SBA 7(a) Loan: Due to the high rejection rate, many small business owners now turn to the U.S. Small Business Administration. Serving as a type of broker, the U.S. Small Business Administration does not in fact lend money but rather serves as a third party who works with established lenders across the nation to guarantee all or part of smaller business loans. Since many lenders have cold feet about lending large sums of money to small business owners, especially those with limited credit history, SBA is there as back up. While it is no guarantee, having the SBA on your side, can help secure a loan with an established lender who may otherwise be unwilling to move forward.
Startup Loan: For new entrepreneurs, startup loans are also an option. While still term loans, these loans can be more flexible since they are designed for borrowers without a long credit history. That said, since they are designed for borrowers new to business, startup loans typically involve intense scrutiny of one’s personal finances. If you’ve already maxed out myriad of credit cards or defaulted on a car, home or student loan, don’t bank on a startup loan from an established lender.
Equipment Financing: If you are a buyer primarily looking to purchase a business for its equipment, equipment financing may be an option. Whether or not you qualify, however, will matter a great deal on the value of the equipment in question. Like a car loan, the value of the loan will be contingent on several factors, including the type of equipment, the price, whether or not the equipment is new or used, and the expected life expectancy of the equipment.
Crowdfunding: While often associated only with startups, today, crowdfunding—in all its guises—is becoming increasingly common in traditional business purchases as well. While you may not be able to raise enough capital for a purchase, crowdfunding may give you the cash flow required to secure a larger loan with an established lender. In other words, while likely not an option for the full funding pie, crowdfunding should not be disregarded as one piece of the funding pie in today’s market.
What Lenders Need to See from Buyers
Once you’ve decided which loan or loans you are going to pursue, you’ll need to get your paperwork in order. On this account, you should be prepared to share your personal credit score, business credit score, tax returns, cash flow statement and current debt. It goes without saying that if any one of these pieces is missing or in disarray, your chances of securing a loan will diminish.
Personal Credit Score: Like applying for a credit card, car loan or house loan, in business, personal credit scores matters too. If you’re over 700, consider yourself in a good position, but in today’s market being over 780 is advised. If you’re hovering in the 600s, you will still have options. If your personal credit is under 600, you may find yourself scrambling and taking time out to spike your score is advised before you seriously go on the market in search of a lender.
Business Credit Score: If you already own a business, your business credit score will also be a factor. On this account, expect lenders to scrutinize your payment history, outstanding debts, length of credit history and debt amounts. Again, the better your score, the more likely you will be to find a lender willing to work with you.
Tax Returns: Most lenders will want to see your last two to three years of tax returns (some may ask to go further back). If you haven’t filed yet this year, provide proof that you are in good standing with the IRS. If you aren’t, don’t expect to find a willing lender.
Cash Flow Statement: A cash flow statement of your business is like an annual report or doctor’s check up. It tells a lender where you are currently at and can reveal a great deal about your business management skills too. Even if you are new to business and have relatively limited cash flow, if your cash flow is proportionate to the size of your current venture, you can make it work in your favor.
Outstanding Debts: On the flipside of cash flow are your outstanding debts. The more debt you have, the less likely you will be to obtain a loan. Also, don’t try to hide your debt. Your personal and business credit scores already reflect your debt to credit ratio, so there’s no use attempting to hide your debt.
What Lenders Need to See from Sellers
If you’re hoping to secure a traditional business loan, lenders are not only interested in your finances but also the financial health of the business you hope to purchase. This means that in addition to scrutinizing your finances, the lender will need to investigate the financial history of the business you intend to purchase. In this case, you’ll need to work with the seller to obtain the following data:
- Balance Sheet: This will give your lender an over all picture of the business’s assets and current value.
- Tax Returns: Your lender will also want to see the business’s recent tax returns.
- Profit Margin: Data on profit margins is also key—if the business is not yet profitable, it will be a harder sell.
The Business Plan
At the end of the day, the most important factor is whether or not the business you are proposing to purchase is perceived to be a business likely to yield a strong return on investment under your leadership. To determine this, lenders consider several factors:
- Valuation: Are you paying a fair price for the acquisition? If you’re paying too much, the ROI will be compromised.
- Your experience: Can you pull this off? Do you have the knowledge and experience to successfully execute this venture?
- Business plan: Do you have a viable business plan? Do you have short- and long-term goals for the business?
- Projections: Are you being realistic about the business’s potential?
When you turn to a lender for a business loan, you’re ultimately asking for more than money. Lenders are there to support your proposed venture, but they are also giving your business plan approval. Of course, anyone who has a history of lending money has already seen many businesses succeed and just as many fail. The onus is on the buyer then to convince the lender that their personal financial history, business history, proposed purchase and business plan are all rock solid. Working with an experienced advisor can help ease some of the burden. After all, since you’re not simply asking for money but also selling yourself and your broader business vision, the process will take time, planning, organization and expertise. With an advisor’s assistance, you can expect the process to go more quickly and to run into fewer obstacles along the way.