Done right, buying an existing business can be an advantageous option for entrepreneurs interested in owning their own company or expanding their existing one, especially if the business has a strong reputation, an established customer base, and a proven track record. Due to these characteristics, it’s often easier to obtain financing for the acquisition of an existing business, rather than for a startup.
The following covers one example of many processes for business acquisition, loan options, as well as some of the factors to consider when pursuing and funding a business acquisition.
One of the first steps in a business acquisition is to outline a strategy. It should cover your business goals, the drive behind the acquisition, geographic parameters, budget, timing, and any other variables that could impact the “why, where, when, and how” of the pursuit.
The strategy should note approximately how long the prospective purchaser plans to be associated with the acquisition. For example, is this a five-year plan with the intention of selling to help fund a near-future retirement? Is it meant to be a lifetime career move? Is it part of a plan to continue acquiring businesses as a way to grow an existing company? This can affect other factors in the strategy such as budget.
The acquisition strategy should also identify the appropriate business to purchase. This phase requires research and an honest assessment of interests, capabilities, access to staffing if needed, and other factors that will help determine if a prospective business is right.
In the case of acquiring a new business, it’s usually best to consider options in which the purchaser is familiar, or better yet, experienced. The reputation of the business, its location, size, number of employees, and financial history should be considered as well.
The same applies to an acquisition meant to help expand an existing business. In addition, it’s essential that any business under consideration offers the complementary capabilities and resources to meet the purchaser’s business needs and goals for expansion.
Creating a list of must-haves and nice-to-haves for any business under consideration for purchase can help in both the search component and the evaluation part of a business acquisition.
The next step is to conduct both an evaluation and a valuation. The evaluation assesses whether a business meets the criteria outlined in the business strategy. If not already covered in the must-haves and nice-to-haves, the evaluation should consider the business’s history, reputation, location, any legal or compliance issues, staffing resources and needs, and market outlook.
A business valuation is the process of determining the fair market value of the business. It should be conducted by a certified and accredited business appraiser affiliated with a nationally recognized association.
Two of the most important factors considered in a business valuation are cash flow and risk. Cash flow can be expressed in many ways, typically either as Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) or Seller’s Discretionary Earnings (SDE). All businesses have some degree of risk due to a market trends, reliance on vendor relationships, competition, legal exposure, and other variables. A business valuation will include an analysis of the company’s risk and quantify it into a percentage known as a Discount Rate or Capitalization Rate.
Armed with the information from the evaluation and valuation, the prospective buyer and seller will negotiate on the price and terms. Engage your trusted legal and financial advisors to draft a letter of intent: both you and the seller will sign this letter of intent to ensure there is agreement on the specifics of the purchase. Lenders require a copy of a signed letter of intent from the seller before committing to financing a project. The contents of the letter will vary based on what the parties agree upon but will typically include items such as:
Scope of key representations and warranties of the seller
Finding the right business to purchase, on its own, can be a time-consuming endeavor. Determining how best to finance the purchase — and securing that financing — can be even more complex.
There are various ways to finance a business acquisition, including using one’s own funds or negotiating seller financing. The most common means, however, is through a business acquisition loan.
A business acquisition loan is a small business loan that's designed for financing the purchase of an existing business or franchise. The amount that can be borrowed and the qualification requirements vary by lender.
Many financial institutions prefer to provide loans for business acquisitions only if they’re guaranteed by the Small Business Administration (SBA). There are various SBA-backed loans, but the most common is the 7(a) loan. It’s available in amounts of up to $5 million with terms up to 25 years.
The SBA limits the rate that lenders can charge for an SBA 7(a) loan. Consequently, the rate on a SBA 7(a) loan tends to be less than that on a conventional loan. Financial institutions may favor SBA-backed loans because the SBA guarantees all or part of the loan if the borrower were to default on the terms of the loan. This enables financial institutions to reduce their risk and receive incentives for making what normally might be considered risky loans.
SBA loan eligibility requirements include being a small business located in the United States with a demonstrated need for the loan. The business must operate in an eligible industry and be owned by U.S. citizens. In addition, loan applicants generally must have:
A business plan and financial projections
Industry experience isn't required, but it's preferred. Firsthand knowledge about the industry in which the business will operate can provide prospective lenders with greater confidence in making the business acquisition loan. More information on SBA loans can be found at https://www.sba.gov/.
Once the completed loan application package is submitted, applicants may have to wait several months for an approval decision. If business acquisition funding is required quickly, alternative financing may need to be considered.
With a conventional term loan, the borrower receives a lump-sum disbursement from the financial institution. The loan is repaid in fixed installments over a set time period.
These types of loans come with higher interest rates and fees than SBA-backed loans. They’re also often issued in smaller amounts than SBA loans, and require shorter payback terms with larger monthly payments. Repayment terms are often in the five-year range, although this varies by lender.
Most term loans are secured, and borrowers may be asked to sign a personal guarantee, which holds the borrower personally liable if the business fails to make payments.
Approval for a term loan is based on many of the same factors as SBA loans.
The primary differences between a conventional term loan and the SBA 7a is the government guarantee which provides for higher loan amounts, longer terms and lower interest rates. It is important to note that the size of the loan requested may be too high for SBA 7a coverage, which would mean the only options are conventional term loans.
Financial institutions consider a broad range of factors when reviewing business acquisition loan applications, regardless of the loan types. Borrowers should familiarize themselves with the financial institution’s loan options and specific requirements.
Being prepared in advance and having all necessary documentation on hand can make the loan process less stressful. The following is some of the information to have available:
It’s advisable for anyone considering acquiring a business or franchise to investigate a variety of financing options and weigh the pros and cons of each. Compare rates and repayment terms. Understand the full scope of any requirements. It’s also important to be
very honest about one’s own financial situation, business acumen, and ability to take on a business or franchise. An expert at Seacoast can walk you through the application process and assist in matching your needs with the right product and service.
For information on business acquisition loan options at Seacoast Bank, contact your local banker below.