What You Need to Know About Financing a Business Acquisition

If you’re planning to buy an online business, it is important to understand the various options for financing a business acquisition. After all, there is no one-size-fits-all approach when it comes to accessing capital. Having a clear idea of the different funding sources available will help you make an informed decision that gets you one step closer to acquisition success. 

In this article we discuss:

• How acquisition financing works
• Different options for funding an acquisition
• What to consider when financing a business acquisition

How Acquisition Financing Works

For many entrepreneurs, the decision to either start a business from scratch or buy an existing business is an important first choice to make. Both have their advantages and disadvantages. For those considering buying a business, it is helpful to know how business acquisition financing works. 

“Acquisition financing can help you buy the right busines.”

Advantages of buying a business

Compared to starting a business from scratch, buying a business has several advantages. For starters, buying an established business saves you the time and energy typically required to get a newly established business off the ground. 

In addition, establishing a product-market fit and creating a customer base from scratch can be a daunting task. When you buy the right business, you can bypass these challenges and immediately start running a company that has a proven track record of success. 

Accepting help from friends and family to fund an acquisition can provide many of the same benefits that utilizing your own personal wealth entails: Fewer hoops to jump through and reduced cost. Of course, some friends and family may not lend their money for free. Your terms will depend on the agreement you and your loved ones arrive at. 

Again, not everyone has the luxury of being able to secure financing from their personal networks. Fortunately, there is a range of other options available. 

SBA loans

SBA loans are one of the most widely used tools when it comes to business acquisition financing. An SBA loan is a loan that is backed by the Small Business Administration, helping to provide a level of security to the lender. 

Critically for you as the buyer, SBA financing can cover up to 90 percent of the total purchase price, leaving you with only a 10 percent down payment. This allows you to purchase a larger or more valuable business than you would otherwise be able to on your own. 

Sellers often also love deals that are financed by SBA loans, as it can allow them to be paid in full at the time of closing. By being able to make an offer that benefits the seller, you are more likely to win the deal in a competitive bidding environment. 

From the perspective of the lender, they generally have three basic requirements for deciding whether or not to approve your loan. These include

• The business can repay the loan
• You are a financially and professionally qualified to run the business
• The purchase deal structure meets their standards

You will need to go through an approval process in order to secure an SBA acquisition loan. We will discuss loan approval considerations in the next section.

“SBA loans are one of the most widely used tools when it comes to business acquisition financing.” 

Banks and credit unions

SBA loans aside, many banks and credit unions offer other loans or debt financing options when it comes to acquisition finance. If you haven’t already, establish a relationship with a lender at your bank to see if a bank loan or other small-business loan may be available to you. 

Seller financing

With a seller-financed deal structure, the buyer pays a percentage of the agreed-upon price at the time of the sale, and the seller finances the rest. With this method, the buyer pays back the seller over the course of the deal terms. 

As you can imagine, many sellers do not want to engage in this financing option; most sellers want the security of having the cash in hand when they sell their business. If a new owner tanks the business after taking over, the seller may not have many options for getting the balance owed to them. 

Whether or not you engage in seller financing, and the exact terms you agree to if you do, will depend on your negotiations with the seller. Depending on their position and the urgency with which they need to sell the business, they may be willing to consider this option.  

What to Consider When Financing a Business Acquisition

If you are thinking about seeking a loan when considering how to finance a business acquisition, it is important to understand what lenders look at when approving loans. 

What lenders look at when approving a loan

When it comes to debt financing, lending institutions look at a wide variety of factors when determining whether or not to offer you a loan. These include

• Personal tax returns and financial statements
• Loan application form
• Business financial statements
• Business plan
• Pro forma financial statements
• Bank statements

“If you are thinking about seeking a loan when considering how to finance a business acquisition, it is important to understand what lenders look at when approving loans.” 

Personal tax returns and financial statements

In most cases, the lender will assume the business will be used to ensure payment on the loan interest and balance. However, your personal finances have a bearing as well. For this reason, they will want to see your financial statements to get a picture of your current situation. 

In order to verify these statements, the lender will also need to see your personal tax returns. In most cases, they are interested in seeing your taxes for the previous three years. 

Loan application form

All loans require you to submit an application form. Given its importance in determining your chances of approval, it is wise to go through the form long before applying to determine how you can improve your overall chances. 

Financial statements for the business

Given that the business is the main way lenders expect the loan to be repaid, they will want to ensure the health of the business. As such, lenders want to see the financial statements of the business you intend to purchase with the loan. This may include cash-flow records, capital on hand, accounting statements, debt levels, and other financial metrics. 

Pro forma financial statements

The lender will also want to have an idea of how the business is likely to perform in the future. In addition to past and current financial statements, they will want to see your projections for expected future performance. 

Pro forma financial statements serve this purpose. When creating these statements, it is important to be realistic and honest in your projections of future business performance.

“By creating a cohesive business plan laying out how you intend to manage and grow the company, you will help instill confidence in your ability to run the business while showing them a clear road map to success.”  

Business plan

The lender will also want to know that you have a feasible business plan in place to achieve the projected performance expectations laid out in the pro forma financial statements. 

By creating a cohesive business plan laying out how you intend to manage and grow the company, you will help instill confidence in your ability to run the business while showing them a clear road map to success. 

Bank statements

By providing bank statements from the business you intend to buy, you allow the lender to verify the reliability of the financial statements, pro forma financial statements, and business plan. 

Conclusion

If you are looking to purchase a business, knowing the financing options available to you is an important first step. By working with a qualified business Advisor to analyze your options, you can secure funding that matches your personal situation in order to be able to make a solid offer on the business of your choosing.