Financing Business Acquisitions
When structuring a business deal, there are endless ways you can finance the transaction. Most acquisitions involve a combination of multiple methods to come up with the purchase price. In this article, we will cover the more common options to consider when negotiating a business acquisition. This will be a brief overview as there’s too much information on this topic to cover in one article. We’ll go into further details about each of these along with some more creative structures in future articles.
Seller Financing
One of the most common tools to use when negotiating a business deal is seller financing. It’s estimated that between 70%-80% of all acquisitions involve some portion of the purchase price to be financed by the seller. On average, sellers are willing to carry 30%-60% of the total purchase price. It’s an excellent marketing tool for sellers to mention they are willing to provide seller financing as an option in their Information Memorandum. Doing so will attract stronger offers and more offers from potential buyers. There are several ways to structure seller financing; either through an earnout, seller-retained equity, or a balloon loan.
Earnouts involve the buyer and seller agreeing on an amount to be paid post-closing that will come from the company’s earnings. Usually these are structured with a 2–3-year term for repayment and they are tied to certain metrics of business performance such as revenue growth, or profit retention. The seller will often stay in the business to some degree to ensure those metrics are being met, so they can achieve their earnout payments.
With seller-retained equity, the seller will sell most of the business to the buyer but keep a minority ownership. This helps lower the purchase price for a buyer and mitigates risk by keeping the seller involved with the business. It helps the seller by liquidating most of their ownership for available cash but keeps them in the company as a consultant so they can continue to earn owner benefits while helping the new owner.
A balloon loan is more common in real estate transactions, but you can see them in business deals as well. The seller will agree to carry a certain amount of the purchase price for a short period of time, usually only 30 to 120 days. These are structured similarly to an earnout in that they are tied to the business reaching certain metrics of performance. The seller gets paid monthly out of either the company earnings or directly from cash the buyer has on hand. They are a great way to assure the buyer that the business will continue to grow, however, the downside is that the total amount of the loan is due at the end. So, buyers will want to make sure they don’t loan more than they can handle within this short period.
Third-Party Financing
Finding a loan from a third-party is a great way to fund a business acquisition. There’s a lot of options with this strategy, and buyers will want to look at each of them to determine what best fits their needs. Some will benefit them with lower interest rates while others may be faster or easier to obtain.
Bank loans are used most often, and there are two types to consider. We recommend first looking into an SBA (Small Business Administration) loan as they currently offer the lowest interest rates around 3.5%. The SBA guarantees these loans for their lending partners up to 75%-85% of the total loan amount. This makes it much less risky for lenders in the event a borrower must default from a business going under. There are several programs offered through SBA from express loans to micro loans, but the one a buyer would most likely use for purchasing a business is the SBA 7(a).
Alternatively, if SBA won’t work because the buyer is already using one or may not qualify, then they can ask a lender about a term-loan. These may not be as good as SBA loans because they offer a lower loan amount, higher down payment, and shorter period for repayment. We have a list of lenders that specialize with business loans, so feel free to ask us for an introduction.
A buyer could also search for a private lender, venture capitalist, or angel investor. These are groups or individual investors who will loan out to entrepreneurs with either their own money or a pool of money from investors. They will typically want higher interest rates between 6%-15%, but funds could be available much quicker than traditional loans. Sometimes they’ll invest for a stake in the business instead of doing a loan, and the buyer could benefit by having the investor as part of their team.
A couple other forms of financing you may see from both banks and private lenders are leveraged buyouts (LBO) or asset backed loans. These are loans that are secured by the assets of the business being purchased. Buyers could leverage a higher loan using these, but they’re riskier because the lender would have a lien on the business assets. The difference between the two is that the LBOs are based off the value the assets bring to the business while asset backed loans are based off how much the assets could sell for if the business fails.
Self-Financing
Nearly every business acquisition will involve some portion of funds being brought to the table by the buyer. There are exceptions like “no money deals” or “no money down deals”, but those are harder to come by, and explaining them is for another topic. For this article, I just want to cover some ways buyers could obtain personal capital to help fund a business transaction.
The most obvious is personal funds from savings accounts or assets easy to liquidate such as stocks or crypto currencies. If the buyer owns another business, they could also do a merger and use capital from their current business to contribute to the purchase price.
One of the most overlooked ways of raising capital is to draw money out of a 401k retirement plan, called ROBS (Rollovers for Business Start-ups). Despite the name mentioning “start-ups”, these can also be used for purchasing preexisting businesses. It’s an easy way to obtain cash relatively fast, and you don’t pay any early withdrawal fees or tax penalties so long as you use it for the intended investment. This isn’t a loan against your 401k, so the money is all yours.
There are a few other ways buyers can come up with personal funds. Homeowners can refinance their house or take out a home equity line of credit. Anyone with life insurance can borrow against their policy, and stockholders can borrow against their shares of stock without selling them.
Combining Financing Methods
Every business acquisition is different, and the methods used to come up with the purchase price will depend on what kind of financing is available to the buyer and how much the seller is willing to carry. A lot of transactions will involve some combination of these three options: seller financing, third-person financing, and buyer’s personal funds. There’s a ton of ways to get creative with these, and there’s more methods not even mentioned here. I’ll be covering some of the no-money deal structures in another article soon. If you would like more details, or just want to talk business, please feel free to reach out to us anytime. We’d love to have a conversation.
