For entrepreneurs looking for an opportunity to own their own company or expand their current enterprise, acquiring an existing business can be a favorable option—especially if the business has a strong reputation, an established customer base and a proven track record for success and profitability.
In fact, industry experts predict that the small business acquisition market is poised for growth in the future. Because of these advantages, it is often easier to obtain financing for the acquisition of an existing business rather than a startup with unknown risks.
In the following guide, we will identify some of the common processes for business acquisitions, business acquisition loan types and other factors to consider when pursuing and funding a business acquisition.
Simply put, a business acquisition is when one company purchases a portion or the whole of another company through buying its stock shares or other assets.
There are various reasons a business acquisition may take place, including an expansion of market share, eliminating competition or gaining valuable access to desirable technologies and products.
The company who is positioned as the acquirer will assume control over some or all of the acquired company’s assets and operations, but also its liabilities. Two examples of business acquisition are asset acquisition and business combination.
With an asset acquisition, specific assets and liabilities of one company are bought by another. This option offers flexibility and is typically chosen when particular components of the target company are either desired or to be avoided from a liability standpoint.
Legal transfers in asset acquisitions are comprised of individual contracts, and the target company remains intact with fewer assets and liabilities.
A business combination is when two or more companies merge into a new entity after the acquiring company purchases a majority interest that gives them control over operations, liabilities and assets.
This type of acquisition is more complex than an asset acquisition and involves legal and regulatory processes that must be considered.
One of the first steps in a business acquisition is to outline a strategy. This acquisition strategy should cover your business goals, the drive behind the acquisition, geographic parameters, budget, timing and other variables that could impact the why, where, when and how of your 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 the right fit.
When acquiring a new business, buyers may want to consider business types in which they have some level of knowledge and experience. Being familiar with the nuances and operational requirement of a particular industry may help ease the purchase and onboarding process post-purchase. The reputation of the business, its location, size, number of employees and financial history should also be considered.
The same applies to an acquisition meant to help expand an existing business. Additionally, it is essential that any business under consideration offers 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.
For example, must-haves may include a facility in a family-friendly area, an in-place staff who are trained and skilled in daily operations or overhead expenses that fall below a certain threshold. Nice-to-haves might include a location in a region with seasonally mild weather year-round, proximity to public transport or ample parking for customers.
Every business acquisition endeavor is unique, so careful evaluation of these needs is a best practice as the strategy is developed.
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 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:
Finding the right business to purchase can be a time-consuming endeavor. Financing a business acquisition—including determining and securing that financing—adds another layer of complexity to the process.
There are various types of business acquisition loans, including using one’s own funds or negotiating seller financing. However, the most common means is through a business acquisition loan.
A business acquisition loan is a small business loan that is designed to finance the purchase of an existing business or franchise. The amount that can be borrowed, qualification requirements and term lengths will vary depending on the business acquisition loan lender and the type of loan chosen to finance the acquisition.
The most common business acquisition loans include:
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 loans backed by the Small Business Administration (SBA). They are 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.
Many financial institutions prefer to only provide small business acquisition loans if they are guaranteed by the SBA. There are various SBA-backed loans, but the most common is the 7(a) loan. It is available in amounts up to $5 million with terms extending to 25 years.
The SBA limits the rate that lenders can charge for an SBA 7(a) loan. Consequently, the rate on an 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 defaults on the terms of the loan. This enables financial institutions to reduce their risk and receive incentives for approving what might normally be considered risky loans.
SBA loan eligibility requirements include being a small business located in the U.S. 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:
Industry experience is not required, but it is 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.
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.
The primary differences between a conventional term loan and the SBA 7(a) are 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 7(a) coverage, which would mean the only options are conventional term loans.
Business lines of credit offer flexible financing by providing companies access to funds up to a predetermined credit limit—much like a credit card. A line of credit can be used for a variety of purposes including covering short-term expenses, managing cash flow or even as safety coverage for unforeseen emergencies.
As needed, a company may withdraw funds, repay them and continue in that cycle without the need to reapply for additional loans. Interest is only applied to the amount borrowed for the duration of the loan.
When applying for a line of credit from a lender, the business’s financial health, creditworthiness and other factors will dictate the credit limit and other terms associated with the line of credit.
Repayment terms typically include minimum monthly payments with fixed or variable interest rates. Business acquisition loan rates are generally higher with lines of credit when compared to traditional term loans due to the flexible convenience offered by this type of funding.
A debt security is a financial instrument used by the acquiring company to borrow funds for a business acquisition. Debt securities represent the debt owed by the acquiring company to a particular lender.
Business acquisition loans may take the form of debt securities such as promissory notes, bonds or loan agreements. These debt securities outline the terms of the loan, including the amount to be borrowed, loan rates, repayment terms and any collateral or guarantees provided by the acquiring company.
Debt securities give companies access to the necessary funds to finance an acquisition and allow the company to raise capital while spreading repayment out over time, which can benefit cash flow management and financial obligations associated with the acquisition.
The primary difference between secured and unsecured loans is that a secured loan requires collateral, whereas unsecured loans do not.
Secured business acquisition loans offer a lower risk for lenders and in turn may provide more favorable loan terms and interest rates for the borrower.
Collateral in the form of business assets from the acquired or acquiring company may be used to obtain a secured business loan—but if a scenario arises where the borrower defaults on the loan, the lender has the option to seize and sell the collateral to recoup the outstanding debt.
In lieu of collateral that can be used to secure a financial institution’s investment, unsecured business loans rely on a borrower’s creditworthiness and financial history, which make them a higher risk for the lender.
Due to that level of risk, these loans may carry higher interest rates, a stricter set of terms and be more difficult to obtain than a secured loan.
Banks and other financial institutions consider a broad range of factors when reviewing business acquisition loan applications, regardless of the loan type. Borrowers should familiarize themselves with the financial institution’s business acquisition loan rates, loan options and specific requirements. To qualify for a business loan through Seacoast Bank, a business must be based in Florida and have been operating for a minimum of three years.
Being prepared in advance and having all the necessary documentation on hand can make the loan process less complicated. The following are some of the recommended information to have available as you begin the loan application process:
For any business owner or entrepreneur seeking to acquire a business, it is advisable to research your business acquisition loan options and weigh the pros and cons of each. Also, ensure that your finances and credit are in proper order prior to beginning the application process.
By comparing loan rates, repayment terms and understanding the full scope of each loan type’s requirements, you are preparing yourself for a successful partnership between you and your lender.
At Seacoast Bank, our locally based business lending experts can walk you through every step of the application journey and assist in matching your needs with the right products and services for your exciting new endeavor in Florida.
To learn more about our business acquisition loan options or to connect with us, find your nearest branch or complete our simple contact form below.
Topics: Start a Business
Equal Housing Lender. Member FDIC. NMLS# 608046
