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Finance

What you need to know about financing a business acquisition

Posted by Celene Robert

April 22, 2022

Image representing a person signing bank papers for a loan.

Entrepreneurs may seek to acquire an existing business to grow their industry presence or to expand into a new market. Starting with an already proven business plan lets them move right into ownership and focus on growth, as well as providing other advantages. Let’s break down the benefits below.

8 benefits of purchasing an existing business

Skipping the startup phase

– By acquiring an established business, entrepreneurs can save time as opposed to building a company from the ground up. The purchaser automatically takes possession of operating manuals, IT platforms and other forms of infrastructure that support the company’s operations rather than scaffolding it all themselves.

Faster expansion

– It is easier to expand on a proven business plan since you don’t need to raise the funds to build the brand on your own.

Immediate cash flow

– Revenue generated by purchasing a business with an existing customer base may cover the cost of your acquisition loan and allow you to draw a salary.

Increases an existing brand’s value

– When you buy a brand that is already recognized, you also gain access to its established products or services, advertising, contracts and employees, among other things, which increase your existing business’s value.

Easier to secure business financing

– It is often easier to get a loan to purchase an existing business than to borrow money for a startup business.

Access to expertise

– By acquiring a business, you gain access to its finance, legal and HR professionals. Having the right team in place will help you focus on growing your customer base and reaching your business goals.

Expands your market presence

– A business acquisition can help an existing company enter into new markets and debut product lines on the basis of its solid reputation and client base, in turn increasing market share.

Speeds up growth

– The existing business’s products or services are already market-tested, so you’ll be in a position to start selling quickly. Trained staff members and pre-existing relationships with suppliers will also expedite growth.

4 main ways to finance a business acquisition

Business owners or aspiring business owners use a business acquisition loan to buy an existing business or franchise. If your current business is a partnership and you want to be the sole owner, you can also use an acquisition loan to buy out your partner. Below we present some of the primary forms of business acquisition loans.

1. SBA loans

The two Small Business Administration business acquisition loan types are the 7(a) and the 504. SBA loans are issued by participating lenders, such as banks and credit unions, and are partially guaranteed by the federal government. These loans have flexible terms of up to 25 years, low interest rates and can be used for various types of business acquisitions of up to $5 million for those who qualify. However, like traditional bank loans, SBA loans have strict requirements. SBA loans are rated as the least-risky loans for banks; they therefore offer the best interest rates to applicants.

2. Term loans

Business owners and entrepreneurs may obtain a term loan through a bank or other traditional lender. Term loans provide borrowers a set amount of funds, which must be repaid with fixed installments that include interest over a set period of time.

If you have a good credit score, you may qualify for a term loan with more attractive payment terms and a lower interest rate.

3. Leveraged buyouts

An LBO entails acquiring a business using a large amount of borrowed funds. The acquired company’s assets are typically used as a form of collateral for the loan, in addition to the acquiring firm’s assets. Thus, the major portion of the acquisition cost is paid out of debt. The major advantages of an LBO are its increased rate of return and that it minimizes the amount of your equity contribution, as well as helping you to purchase the biggest possible business.

4. Crowdfunding and peer-to-peer lending

Crowdfunding and P2P lending can be used to raise funds for a small business acquisition. It may be a good option if you are looking to acquire a business that you foresee as having great potential yet to be tapped.

Crowdfunding and P2P lending may transpire through a group of people or through third-party online intermediaries that connect the lenders/investors with the business buyers. Sometimes, the buyer of the business can also get funding from the seller rather than a financial institution.

Terms to consider when applying for a business acquisition loan

Some acquisition loans use the asset being acquired as a collateral for the loan – this is especially helpful when your business doesn't have sufficient value to secure a loan with separate assets. In some instances, using equipment as collateral to secure a loan helps expedite the loan process. And, if you were to default, the lender would simply take ownership of the equipment.

Depending on your business, type of financing and your business’s qualifications, the lender may require a down payment of 10% to 30% of the total transaction. Loan amounts, interest rates and repayment terms vary from lender to lender and based on your credit score. However, in some cases, the business you are buying can function as a form of collateral, especially if it has real estate or equipment.

Basics you’ll need to get a business acquisition loan

Before you buy a business, keep in mind you need to perform due diligence about your target company. The information that the lender will likely require includes:

• Your professional business experience.
• A business plan that addresses why the loan is needed and how it will be used.
• Business valuations.
• Personal and business tax returns.
• Personal and business bank statements.
• A signed letter of intent.
• Personal and business credit histories.
• Business financial statements.
• Business debt schedule.
• Business projections.
• Legal business documents, including contracts, ownership agreements (including terms of sale), business certifications and licensing and affiliations.
• Previous years’ federal income tax returns of the business you’re planning to buy.
• Profit and loss statement from the existing business.
• Your loan application history.

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Finance

What you need to know about financing a business acquisition

8 benefits of purchasing an existing business

Skipping the startup phase

Faster expansion

Immediate cash flow

Increases an existing brand’s value

Easier to secure business financing

Access to expertise

Expands your market presence

Speeds up growth

4 main ways to finance a business acquisition

1. SBA loans

2. Term loans

3. Leveraged buyouts

4. Crowdfunding and peer-to-peer lending

Terms to consider when applying for a business acquisition loan

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