How to Finance a Business Acquisition
When financing a business acquisition, several factors and options are to consider. First, you can finance an acquisition through debt, equity, or a hybrid of the two. Each option has its own benefits and drawbacks, so it’s vital to understand what each involves before deciding.
Secondly, there are several available prospects for obtaining the capital you need. Potential options range from going to traditional lenders like banks or using an array of alternative and more creative options. Each of these sources will have different requirements, costs, and expectations for your business.
This blog post will go over the most common methods for obtaining acquisition financing. We’ll also provide tips on finding the proper funding for your needs. So, whether you’re an individual business owner looking to acquire another company or a CFO trying to find the best financing option for an upcoming deal, read on for more information.
Financing a Business Acquisition
You typically have two options when financing a business acquisition: debt or equity.
Debt financing is when a business takes out a loan from a bank or other lending institution. The funds are then used to finance the acquisition. This type of financing is relatively common, especially for smaller deals.
On the other hand, equity financing involves selling shares of your company to investors to raise money for the deal. This is more commonly used in more significant transactions, as it can provide more capital than debt financing.
The correct choice will rely on several factors, including the size and complexity of the deal and your finances.
There are several different debt financing alternatives to choose from, and your unique circumstances will determine the best option for the arrangement. Types of debt financing include:
Term loans: A term loan is borrowed from a bank or other lending institution as a lump sum. A term loan is typically repaid over a set time, generally at least five years.
Lines of credit: A line of credit is a revolving loan that allows you to borrow money as needed. A line of credit is helpful if you need to finance a deal quickly or if a term loan doesn’t fit your needs.
Bridge loans: A bridge loan is a short-term loan used to finance the gap between the purchase price of a business and the funds available from other sources. This type of loan is typically repaid within one to two years.
When it comes to equity financing, there are two routes: private equity and public equity.
Private equity occurs when a group of investors (usually individuals or companies) buys a controlling interest in a company. This financing is often used for bigger deals, as it can provide more capital than debt financing.
Public equity is when a company sells shares of its stock to the public. This type of financing is typical for smaller deals, as it doesn’t require the company to give up control of its business.
In the end, your choice should include numerous considerations, including the size and complexity of the transaction, your financial status, and the terms offered by lenders. Therefore, it’s essential to research and shop around to find the best deal and correct fit for you.
Common Options for Financing an Acquisition
There are many ways to finance your acquisition via equity and debt financing. Below, we’ll discuss four of the most common options that you can use.
Private investors/lenders can be an excellent option for financing. They often have more flexibility than institutional investors, and they’re more likely to invest in a company that is not yet profitable. However, private investors typically require a higher return on investment than institutional investors do, so you’ll need to be prepared to offer them a good deal.
If the seller of the business you’re acquiring is willing to take a note, this can be a great way to finance the deal. A seller note is essentially a loan collateralized by the company’s assets and possibly a pledge of shares or another type of corporate guarantee. After completing the sale with a seller note, the seller agrees to act as a lender to the purchaser and thus receive part of the purchase price over time. This option is useful if you don’t have the capital to finance the whole deal yourself and is also viewed favorably by other lenders who see a Seller Note as a vote of confidence in the business by the former owner.
Commercial banks are a popular source of financing for acquisitions. As mentioned before, they offer a variety of loan products, including term loans, lines of credit, and bridge loans. They’re also familiar with the acquisition process and can help get your deal done quickly. Bank loans are typically less expensive than loans from private investors or alternative lenders.
Asset-based lenders are another option for companies that need debt financing. These lenders provide loans collateralized by the assets of the company. This can be a valuable opportunity if you don’t have enough cash flow to qualify for a loan from a commercial bank. In addition, these loans are secured by the company’s assets, which can help get a deal done quickly. However, interest rates usually are higher than those provided by commercial banks.
There are other less traditional methods that you can use to finance an acquisition, including factoring, receivables financing, and vendor financing.
Factoring is when a company sells accounts receivable (invoices) to a third party for immediate cash. This method can be helpful in situations where the company needs capital quickly but doesn’t have the time to go through the traditional lending process.
Receivable financing is similar to factoring, but it involves a longer-term relationship with the lender. The business sells its accounts receivable to the lender, who then advances money against those invoices. Receivable financing can be helpful in situations where the company needs more capital than what is available through factoring.
Vendor financing is when a company gets a loan from its suppliers to purchase inventory or pay for other expenses. This method can be helpful if the company doesn’t have enough cash flow to cover the current costs.
How to Find the Right Business Acquisition Funding
No matter which method of acquisition financing you choose, it’s necessary to find the right backing for your needs. Talk to a mergers and acquisitions advisor to learn more about the different options available to you and find the one that is best suited for your business.
It’s important to remember that the options mentioned above may be combined if needed, so don’t be afraid to explore your options.
Here are questions to ask if you’re looking for acquisition financing that fits your needs:
- How much do you need to finance the deal?
- What are the terms of the offered loan?
- What is the interest rate?
- How long do you have to pay it back?
- Is there a prepayment penalty?
- What are the fees associated with the loan?
- How is the loan structured?
- What are the collateral requirements?
- How much time do you have to complete the payment?
These are just a few of the questions you should ask yourself when looking for acquisition financing. After these considerations, seek advisory services to get more information and find the proper selection for you.
Tips for Securing Financing for an Acquisition
If you have researched all your options and are still having trouble securing the financing you need for your acquisition, here are a few tips to help.
Put together a great business plan.
If you’re looking for financing from a bank or other traditional lender, you will need to put together a business plan. This document will outline your business goals, strategies, and how you plan to repay the loan. A well-designed business plan might convince a lender that you are serious about your purchase and have a high probability of success.
It will also show that you have done your homework and are knowledgeable about the acquisition.
Get a commitment from an existing lender.
If you already have a relationship with a lender, they may be more likely to finance your acquisition and offer you a lower interest rate. In addition, this process can be more direct since they already know and trust your business.
With existing lenders, it is crucial to have a clear understanding of the terms and conditions of the loan before you proceed. This will help you ensure there are no surprises down the road.
Choose an appropriate business to acquire.
Lenders want to know why you are buying a business and how it will improve your current one. They also want to know if overlaps and synergies exist between the acquirer and the target. Furthermore, they want to see the target’s financials to ensure it is a good investment.
Do your due diligence on the target company and provide a convincing argument for why this is a smart business decision. Financing will be challenging if your lenders do not buy into your reasoning behind your business acquisition.
Conclusion – Business Financing Options
Financing a business acquisition can seem like a daunting task, but it can be a relatively straightforward process with planning and research. There are many different choices to make, so take the time to find the one that is best suited for your needs. And remember, don’t be scared to ask for help. Our mergers and acquisitions advisors at Beacon Mergers & Acquisitions can help you navigate the world of acquisition financing and find the right funding for you.