Financing the Business Acquisition

The epidemic of corporate downsizing in the U.S. has made owning a business a more attractive proposition than ever before. As increasing numbers of prospective buyers embark on the process of becoming independent business owners, many of them voice a common concern: how do I finance the acquisition?
Prospective buyers are aware that any credit crunch prevents the traditional lending institution from being the likely solution to their needs. Where then, can buyers turn for help with what is likely to be the largest single investment of their lives? There are a variety of financing sources for business acquisition loans, and buyers can find one that fills their particular requirements. (Small businesses--those priced under $100,000 to $150,000--will usually depend on seller financing as the chief source.) For many businesses, the following are the best routes to follow:
Buyer's Personal Equity
In most business acquisition situations, this is the place to begin. Typically, anywhere from 20 to 50 percent of cash needed to purchase a business comes from the buyer and his or her family. Buyers should decide how much capital they are able to risk, and the actual amount will vary, of course, depending on the specific business and the terms of the sale.
Seller Financing
One of the simplest--and best--ways to finance the acquisition of a business is to work hand-in-hand with the seller. The seller is the best source for a business acquisition loan. The seller's willingness to participate will be influenced by his or her own requirements: tax considerations as well as cash needs.
In some instances, sellers are virtually forced to finance the sale of their own business in order to keep the deal from falling through. Many sellers, however, actively prefer to do the financing themselves. Doing so not only can increase the chances for a successful sale, but can also be helpful in obtaining the best possible price.
The terms offered by sellers are usually more flexible and more agreeable to the buyer than those from a third-party lender. Sellers will typically finance 30 to 50 percent--or more--of the selling price, with an interest rate below current bank rates and with a far longer amortization. The terms will usually have scheduled payments similar to conventional loans; the tax picture, however, can be better than with straight debt.
As with buyer-equity financing, seller financing can make the business more attractive and viable to other lenders. In fact, sometimes outside lenders will refuse to participate unless a large chunk of seller financing is already in place.
Small Business Administration
Thanks to the U.S. Small Business Administration Loan Guarantee Program, favorable financing terms are available to business buyers. Similar to the terms of typical seller financing, SBA loans have long amortization periods (ten years), and up to 70 percent financing (more than usually available with the seller-financed sale).
SBA loans are not, however, a given. The buyer seeking the loan must prove stability of the business and must also be prepared to offer collateral--machinery, equipment, or real estate. In addition, there must be evidence of a healthy cash flow in order to insure that loan payments can be made. In cases where there is adequate cash flow but insufficient collateral, the buyer may have to offer personal collateral, such as his or her house or other property.
Over the years, the SBA has become more in tune with small business financing. It now has a Lo-Doc program for loans under $100,000 that requires only a minimum of paperwork. Another optimistic financing sign: more banks are now being approved as SBA lenders.
Lending Institutions
Banks and other lending agencies provide unsecured loans commensurate with the cash available for servicing the debt. ("Unsecured" is a misleading term, because banks and other lenders of this type will aim to secure their loans if the collateral exists.) Those seeking bank loans will have more success if they have a large net worth, liquid assets, or a reliable source of income. Unsecured loans are also easier to come by if the buyer is already a favored customer or one qualifying for the SBA loan program.
Although the terms may sound attractive, most business buyers are unwise to look toward conventional lending institutions to finance their acquisition. By some estimates, the rate of rejection by banks for business acquisition loans can go higher than 80 percent.
With any of the acquisition financing options, buyers must be open to creative solutions, and they must be willing to take some risks. Whether the route finally chosen is personal, seller, or third-party financing, the well-informed buyer can feel confident that there is a solution to that big acquisition question. Financing, in some form, does exist out there.

Seller Financing: It Makes Dollars and Sense

When contemplating the sale of a business, an important option to consider is seller financing. Many potential buyers don't have the necessary capital or lender resources to pay cash. Even if they do, they are often reluctant to put such a hefty sum of cash into what, for them, is a new and untried venture.

Why the hesitation? The typical buyer feels that, if the business is really all that it's advertised to be, it should pay for itself. Buyers often interpret the seller's insistence on all cash as a lack of confidence--in the business, in the buyer's chances to succeed, or both.

The buyer's interpretation has some basis in fact. The primary reason sellers shy away from offering terms is their fear that the buyer will be unsuccessful. If the buyer should cease payments--for any reason--the seller would be forced either to take back the business or forfeit the balance of the note.

The seller who operates under the influence of this fear should take a hard look at the upside of seller financing. Statistics show that sellers receive a significantly higher purchase price if they decide to accept terms instead of having the buyer seek a commercial business acquisition loan. On average, a seller who sells for all cash receives 69.9 percent of the asking price. This adds up to a 15.8 percent difference on a business listed for $150,000, meaning that the seller who is willing to accept terms will receive approximately $24,000 more than the seller who is asking for all cash. The seller who asks for cash receives, on average, a purchase price of 36 percent of annual sales; compared to the seller accepting terms, who receives an average of 42 percent of annual sales.

Even with these compelling reasons to accept terms, sellers may still be reluctant. Selling a business can be perceived as a once-in-a-lifetime opportunity to hit the cash jackpot. Therefore, it is important to note that seller financing has advantages that, in many instances, far outweigh the immediate satisfaction of cash-in-hand.

Seller financing greatly increases the chances that the business will sell.

The seller offering terms will command a much higher price.

The interest on a seller-financed deal will add significantly to the actual selling price. (For example, a seller carry-back note at eight percent carried over nine years will double the amount carried. Over a nine-year period, $100,000 at eight percent will result in the seller receiving $200,000.)

With interest rates currently the lowest in years, sellers can get a much higher rate from a buyer than they can get from any financial institution.

The tax consequences of accepting terms can be much more advantageous than those of an all-cash sale.

Financing the sale helps assure the success of both the sale and the business, since the buyer will perceive the offer of terms as a vote of confidence.

Obviously, there are no guarantees that the buyer will be successful in operating the business. However, it is well to note that, in most transactions, buyers are putting a substantial amount of personal cash on the line--in many cases, their entire capital. Although this investment doesn't insure success, it does mean that the buyer will work hard to support such a commitment.

There are many ways to structure the seller-financed sale that make sense for both buyer and seller. Creative financing is an area where your business broker professional can be of help. He or she can recommend a variety of payment plans that, in many cases, can mean the difference between a successful transaction and one that is not. Serious sellers owe it to themselves to consider financing the sale. By lending a helping hand to sellers, they will, in most cases, be helping themselves as well.