Financing a business acquisition is difficult at the best of times.
Most financing options require you to give up something, whether it’s control, parts of your business or growth plans.
Then there’s the business acquisition loan.
Loans are a form of business acquisition financing where you don’t need to give up any part of your new business. Let’s take a look at the different ways to secure a business acquisition loan.
Overview – The Best Services For Business Acquisition Loans
According to our research, these are the best services for business acquisition loans.
Different Business Acquisition Loan Types Explained
These services will provide your small business venture with the capital you need. But they all work slightly differently.
SBA 7(a) Business Acquisition Loan
U.S. Small Business Administration backed loans (SBA loans) are low interest loans for small business owners. The SBA 7(a) is one of the most popular SBA loan programs, and it’s great for business acquisition purposes.
It’s a maximum loan amount of $5M, which is plenty to fund a small business acquisition.
To be eligible, the business must operate for profit, have reasonable owner equity, and operate within the U.S. or its territories.
When using the 7(a) loans as small business loans, the buyer must inject a certain amount of equity into the purchase, typically around 10-20%. The exact percentage can vary based on the lender’s requirements and the specifics of the deal.
The SBA 7(a) loan program can be an attractive option for entrepreneurs looking for a business acquisition loan, but it’s best to work with a lender familiar with the SBA process to navigate the application and approval procedures effectively.
SBA 504 Business Acquisition Loan
The SBA 504 loan program is another U.S. Small Business Administration loan offering, primarily designed to support the purchase of major fixed assets, such as real estate and equipment.
While the 7(a) program is more commonly associated with business acquisition loans, the 504 program can be used in conjunction with business acquisitions if there’s a significant real estate or equipment component.
It’s primarily meant for the purchase, construction, or renovation of commercial real estate and large equipment. It can be part of a business acquisition if such assets are a major component of the purchase.
Funds must be used for fixed assets. This can include purchasing land or existing buildings, improving existing facilities, an existing business, or buying long-term machinery.
The assets being financed will typically serve as the primary collateral for the loan.
One of the goals of the 504 program is job creation. Typically, businesses must create or retain one job for every $65,000 provided by the SBA, with certain exceptions.
Conventional Business Loan
Conventional loans from banks or financing services are a common financing method for business acquisitions.
While they don’t have the backing of a government guarantee like SBA loans, they can be a suitable option for businesses with strong financials and those looking for more flexibility or quicker approval.
Rates can be fixed or variable, determined by the bank’s lending criteria and prevailing market conditions. Typically, conventional bank business loans might have higher interest rates than SBA-backed loans due to the lack of government guarantee.
Banks will assess the financial health of both the acquiring company and the target business. They’ll look at credit scores, financial statements, cash flow projections, and the business plan.
Lenders often require collateral to secure the loan. This could be assets of the business being acquired, other business or personal assets, or a combination.
Unlike SBA loans, which come with specific guidelines and requirements, conventional bank loans might offer more flexibility in terms and conditions, as they aren’t bound by SBA rules.
Risks For Borrowers:
If the borrower defaults, the bank can seize the collateral. Additionally, failing to repay can negatively impact the borrower’s credit score and future borrowing ability.
Seller Financed Business Acquisition Loan
Seller financing, also known as owner financing, involves the seller of a business offering a business loan to the buyer to facilitate the purchase.
Instead of the buyer obtaining a loan from a traditional financial institution, they agree to pay the seller in installments over a specified period.
The interest rate, repayment schedule, and terms are negotiated between the buyer and seller. Rates might be comparable to conventional loans, but the flexibility in setting terms can be a significant advantage.
For buyers, seller financing can offer more flexible terms and may be available even if they don’t qualify for traditional bank loans. For sellers, it can expedite the sale of the business and potentially fetch a higher selling price.
Additionally, the interest earned can provide an added income stream.
Risks
For Sellers: The primary risk is the buyer defaulting on the business acquisition loan. If the business fails under the new owner, the seller might reclaim a business that’s less valuable than when sold.
For Buyers: Since seller financing can be more flexible, buyers might end up paying a premium for the business. Pay attention to business valuation.
Asset-Based Business Acquisition Loan
Asset-based loans (ABL) are a type of financing where the borrower uses their company’s assets as collateral to secure a loan.
These assets can include accounts receivable, inventory, machinery, real estate or an existing business.
The amount a borrower can obtain is typically a percentage of the value of the pledged assets. For instance, a lender might provide 80% of accounts receivable value and 50% of inventory value.
Rates for ABLs can vary based on the lender, the quality and liquidity of the assets, and prevailing market conditions. Typically, they might be higher than traditional loans due to the perceived risk.
ABLs can provide businesses with quick access to capital, especially if they have significant assets but might be facing cash flow challenges. They can be particularly useful for companies with seasonal operations or rapid growth.
Risks:
For Borrowers: If the borrower defaults, the lender has the right to seize and liquidate the assets used as collateral, which can disrupt business operations.
For Lenders: The value of assets can fluctuate. If they decrease significantly in value, the loan might become under-collateralized.
4 Essentials for Securing a Business Acquisition Loan
When considering a business acquisition loan, it’s essential to understand the eligibility criteria lenders use to approve or deny your application. Below are some of the key factors lenders will assess.
1. A Good Credit Score
A good personal credit score plays a significant role in securing a business acquisition loan, particularly if your business is new or you’re a sole proprietor. Lenders typically look for a good or excellent credit score (typically 680 or higher) as it indicates a lower risk of default.
To improve your chances, review your credit report, and address any discrepancies or negative items.
2. Demonstrable Business Experience
Demonstrating a solid background in your industry, as well as prior managerial experience, can make your application more attractive.
Be ready to provide:
- A detailed business plan
- Industry experience and skills
- A proven track record of success
- References or testimonials
3. Solid Cash Flow
Cash flow is the lifeblood of any business. Lenders need to see that your company generates enough cash flow to cover loan payments. To assess your cash flow situation, lenders will typically examine:
- Financial statements
- Profit and loss statements
- Balance sheets
Strive to maintain positive cash flow, as this will show the lender that your business is financially stable and capable of repaying the loan.
4. Collateral to Secure The Loan
For most business acquisition loans, lenders require collateral as security in case you default on the loan. Collateral could include:
- Real estate
- Equipment
- Accounts receivable
- Inventory
- An existing business
Offering more substantial collateral can increase your chances of approval and may lead to more favorable loan terms.
Pros and Cons of Business Acquisition Loans
A business acquisition loan offers numerous advantages, but also some notable drawbacks.
Benefits of Business Acquisition Loans
- No need to give up business equity. That’s my favorite part of business acquisition loans.
- You gain instant access to cash which can be crucial for a successful acquisition. This financial support allows you to seize opportunities quickly, without being slowed down by insufficient funds.
- Additionally, acquiring an established business often offers less risk than starting one from scratch.
- You’ll benefit from an existing customer base, trained employees, and a proven business model.
- Acquisition loans often come with flexible repayment terms, catering to your business’s growing needs and offering more control over your cash flow.
Drawbacks of Business Acquisition Loans
- One of the main challenges is securing the loan itself. Lenders may require a solid credit history, collateral, and a strong business plan. Meeting these requirements can be difficult, particularly for smaller businesses without an extensive financial track record.
- Business acquisition loans can be costly. Interest rates, fees, and loan terms vary, potentially increasing the overall cost of the acquisition. It’s essential to assess all aspects of the loan to ensure it’s the right investment for your needs.
Alternatives to Business Acquisition Loans
Of course a business acquisition loan isn’t the only way to get funding for your investment. There are other financing options available too. Here’s a rundown.
Private Equity Firms
Private equity firms can be a viable alternative to a business acquisition loan.
Private equity firms often require some control over the company they invest in, so make sure you are comfortable with any changes they might implement.
Remember, private equity funding might involve giving up some equity in your company, but it could be a smart option if you’re looking for a larger capital infusion.
Venture Capital Firms
Venture capital is another alternative to business acquisition loans.
Venture capital firms typically invest in high-growth companies and may offer a more hands-on approach to involvement in the business.
While acquiring funds from a venture capital firm may be more challenging, if your business has a strong growth potential and a clear exit strategy, this could be an option for you.
Keep in mind that, like private equity firms, venture capital firms will also require significant equity in your company.
Family and Friends Funding
Lastly, there’s always the option of asking family and friends for funding.
This can be a more informal way to secure the necessary funds for your business acquisition.
However, be aware of the potential risks and challenges involved in mixing personal relationships with business transactions.
It is always best to clearly outline the terms of the funding agreement in writing, specify the repayment terms, and ensure both parties understand the expectations. This will help minimize any potential conflicts or misunderstandings in the future.
Your Turn
As you see, there’s a variety of different business acquisition loans available. If you’re dead set on this financing method, you now know what’s ahead of you.
Whether it’s SBA business acquisition loans or the conventional small business loan from your favorite finance company, the process to secure it is pretty much the same.
Take a look at the business acquisition loan options available. If none of them really floats your boat, remember that there’s plenty of equity financing options available as well to pursue your investment plans. Good luck.
