Components of a Small Business Acquisition Loan
When a small business is looking to expand and grow, it’s common to seek financing options. One popular option is small business acquisition loans. This type of loan can help finance the purchase of an existing business or the merger of two businesses.
In this article, we’ll get into the components of a small business acquisition loan.
How Do Acquisition Loans Work?
Acquisition loans are loans used to finance a business’s purchase. The loan is used to pay for the business and any associated costs, such as legal fees and closing costs. Acquisition loans are a popular way to purchase a business because they offer relatively low-interest rates and flexible repayment terms.
Some acquisition loans can be unsecured, meaning the lender does not require collateral. However, the lender may require the borrower to personally guarantee the loan and require a good credit score.
Challenges To Securing A Business Acquisition Loan
Small businesses are the backbone of the American economy. They account for nearly two-thirds of all private sector jobs and more than half of all U.S. exports. A loan is almost always required to complete the deal when a business is ready to sell or acquire another business.
Yet, securing a business acquisition loan can be a daunting task. Numerous roadblocks can prevent small business owners from getting the financing they need to buy or sell their company.
The most common challenge is finding a lender willing to finance an acquisition loan. Banks are hesitant to make these loans as they are considered high risk. This means that small business owners often have to turn to alternative lenders. Lenders are often reluctant to extend credit to small businesses, and when they do, the terms can be onerous.
Another obstacle is the lack of available capital. If the business doesn’t generate positive cash flow, lenders will likely dismiss the idea of approving an acquisition loan.
There are several other key roadblocks that small business owners need to overcome to secure a business acquisition loan:
- Limited financial history to determine the business valuation: Small businesses typically have a less financial history than large corporations, which makes it harder for lenders to assess their creditworthiness.
- Lack of collateral: Some lenders are often reluctant to extend credit to businesses that don’t have significant collateral to offer as security.
Here are some additional major challenges you’ll typically have to overcome to secure a small business acquisition loan.
Lenders are cautious about loans that finance goodwill transactions. Goodwill is the intangible value of a company’s name, reputation, customer base, and other factors contributing to its success.
A lender may be more likely to approve a loan if it is secured by assets of the acquired company rather than by the buyer’s goodwill.
Goodwill is best defined as the sale price minus the value of the assets after debts have been paid. It represents the projected future earnings the business will be able to earn above the current worth of its resources.
Most lenders have no interest in financing goodwill.
This will usually increase the down payment needed to complete the sale and/or the acquisition of financing.
To allow a seamless transition, the seller may offer transitioning assistance for a period of time. This could mean an agreement between the current owner and new owner in financing options or training sessions and tools to assist and continue the legacy of the day-to-day operations.
The combination of transitional support and financing by the vendor creates a positive vested interest where it is in the seller’s best interest to help the buyer successfully transition all aspects of ownership and operations.
Failing to offer assistance could lead to the seller not receiving some of the earnings in the future if the enterprise were to suffer or fail under new management.
This is usually an appealing quality to lenders as the risk of loss caused by transitions is reduced.
The potential for a business to experience negative consequences due to a change in ownership, management, or structure is known as business transition risk.
This can include financial instability to a loss of customers or key employees. In order to mitigate these risks, it is important for businesses to have a solid transition plan in place. You can demonstrate your agreement by showing the lender your signed letter of intent.
A letter of intent outlines the actions of both parties to ensure the business succeeds after a business acquisition.
A lender has to be confident that the business can continue performing at its current level. This implies that a strategic plan must be established to handle delays in projected returns.
Sales of Asset Vs. Stock Sale
An asset sale is the sale of assets and liabilities, whereas a stock sale is the sale of an owner’s share in a business entity. There are many crucial considerations when determining the type of sales contract. Tax consequences and possible liabilities are the main factors to consider.
Buyers may find it easier to avoid potential liability during an asset sale than in a share sale. Buyers may want to avoid volatility and possible lawsuits such as contract claims, product claims, employment-related lawsuits, and other possible claims.
Many sellers would rather sell the shares of their business to take advantage of the benefits on their tax returns.
In an asset sale, buyers and sellers are subject to different taxation than in stock sales. While intangible assets, such as goodwill, are subject to capital gains tax rates, tangible assets may be taxed at a higher ordinary income tax rate.
Because business liability can be hard to evaluate, there is a greater perceived threat to potential investors when considering an application for a small business loan related to a share purchase.
Risks Associated with the Market
The process of acquiring a business loan is indeed challenging for small businesses. One reason for this is the market risk that lenders face when issuing loans.
In order to mitigate this risk, lenders typically require businesses to provide detailed information about their operations and projections for the future. This can be difficult for small businesses that are in the early stages of development and may not have a lot of historical data to share.
Questions to consider: How is the business distributed between growing, mature, or declining market segments? How does the business fit within the competitive dynamics of the market, and what specific change would lead it to increase or decrease its influence?
A lender must be confident that the business can be successful for at least the period the business acquisition loan will be outstanding.
This is important for two reasons. First, an uninterrupted cash flow will obviously mean a much smoother loan repayment process. Second, a stable business has a greater probability of resale.
Suppose an unexpected event makes the business can no longer pay its debt. In that case, the lender can trust that the business can still generate sufficient resale revenue to cover the outstanding debt.
Local markets are simpler to assess for a banking partner or investor than a company with a wider geographic reach. A regional lender or investor can easily access a business that concentrates on the local community. A business with a regional focus can also be more familiar with the local economy.
Business Proven Profitability
Another challenge to securing a business acquisition loan is demonstrating that the business is worth investing in. Lenders want to see evidence that the company has potential for growth and profitability. This can be difficult to demonstrate without accurate financial statements and forecasts.
Small businesses also face competition from larger companies when seeking acquisition loans. Lenders are more likely to issue loans to larger businesses with a proven track record and are considered less risky investments.
Personal Net Worth
The majority of business-purchase loans necessitate the buyer to make an equity injection.
An equity injection is also known as a down payment.
Usually the down payment must be at least a third of the potential owner’s net worth, with their remaining personal equity equaling the entire fair market value of the loan.
Statistics show that the larger the business acquisition loan required, the more likely the likelihood of default.
Some SBA lenders demand up to 10 percent of the total project cost as a minimum equity injection. Other private lenders may demand higher equity injections.
A Beginner’s Guide to Securing a Business Acquisition Loan
The process of acquiring a business loan is usually complex, and there are a variety of factors that lenders consider when determining whether to approve a loan application. In order to increase your chances of securing a business acquisition loan, it is important to be prepared and to understand the basics of the lending process.
First, you will need to compile all of the necessary documentation, including your business plan, financial statements, bank statements, business credit, and credit history.
How To Obtain A Business Acquisition Loan?
To obtain a business acquisition loan, the small business owner should approach a commercial bank or other lending institution and submit an application.
The loan application will require detailed information about the business, including its financial history, projected cash flow, and collateral.
The lender will review the application and may request additional documentation or information before making a decision. If the loan is approved, the business owner will need to sign a contract agreeing to the terms of the loan.
Types Of Business Acquisition Loans
There are certain types of business acquisition loans. Instead, the business loan market provides several different ways to acquire other businesses, such as term loans and loans, government-guaranteed loans, or startups. Each loan is different depending on the situation.
When a business is ready to grow and expand, there are a few different types of loans available to them through the Small Business Administration, also known as SBA loans. The most common small business loan is the SBA 7(a) loan. The 7(a) loan can be used for many reasons, such as purchasing inventory, real estate, or expanding the business.
Another type of SBA loan is the 504 loan. The SBA 504 loan is for businesses that want to purchase commercial property or equipment. The down payment requirement is lower than other types of loans, and the interest rates are also typically lower.
The third type of SBA loan is the microloan. This loan is for businesses that are just starting out or have been in business for less than two years. In other words, it can help finance a business in its startup phase. The maximum amount that can be borrowed with a microloan is $50,000.
Choose The Best Business Acquisition Loan For Your Needs
When looking to finance a business acquisition, there are a variety of loan options available.
The best option for your needs will depend on the purpose of the loan, the amount of money you need to borrow, and your credit history. Some common business acquisition loans include term loans, lines of credit, and SBA loans.
Term loans are fixed-amount loans that must be repaid over a set period of time.
A line of credit loan is a type of loan where the borrower is given access to a certain amount of money that they can borrow from time to time.
SBA loans are small business administration loans that help businesses start, grow, and succeed. The SBA is a government agency that provides low-interest loans to small businesses. The loans can be used for a variety of purposes, including starting a business, buying equipment or inventory, expanding or renovating an existing business, and working capital.
3 Benefits Of Business Acquisitions
When a business acquires another, it gains several potential benefits. This includes:
- Increased market share – With a larger market share, the business can become more profitable as it has a larger customer base to sell its products and services to.
- Increased economies of scale – By combining the operations of two businesses, the business can take advantage of increased efficiencies and cost savings. This can lead to a decrease in the cost of goods sold and an increase in profitability.
- Exposure to new markets and products – When a company acquires another company, it gains access to that company’s customer base, products, and distribution channels. This can give the acquiring company a competitive advantage by allowing it to expand into new markets or sell new products.
Acquisition loans are loans used by a business to purchase or sell another company. These purchase transactions cannot be carried out by a business’ normal cash flow, and therefore business owners can use loans as a way to buy a business without raising capital to complete the transaction.
Acquisition loans are very common in rapidly growing companies or companies that want to expand. The components of small business acquisition loans include goodwill, transition, risk, profitability, and net worth. You can secure a business acquisition through the private sector or through the government. There are loans such as the SBA 7 a loan, 504, or microloan, which are all SBA backed loans.