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Small Business Advice

5 Key Components Of A Small Business Acquisition Loan

Securing a loan to acquire a small business presents significant hurdles. Meeting the criteria for such a loan can be a challenging process, to put it mildly. When selling a highly profitable business, the price is likely to include a substantial amount of goodwill, which can be challenging to finance.

Conversely, if the business is not generating profit, it can be hard to find lenders, even if the assets being acquired are worth significantly more than the sale price. Business acquisition loans, or financing for changes in ownership, can vary greatly from one situation to another. Nevertheless, here are the primary obstacles you will generally need to overcome to secure financing for acquiring a small business.

Financing Goodwill Goodwill is defined as the difference between the purchase price and the resale or liquidation value of a business's assets after clearing any liabilities associated with those assets. It signifies the anticipated future earnings of the business that exceed the present value of its assets.

Most financial institutions are generally reluctant to fund goodwill, which effectively raises the down payment required to finalize the transaction. Alternatively, it may necessitate obtaining some form of financing from the seller, such as a vendor loan. Seller backing and vendor loans are quite common in the transfer of ownership of a small business. If these elements are not initially included in the sale terms, it might be beneficial to inquire whether the seller would be willing to offer support and financing. There are some excellent reasons why asking the question could be well worth your time.

In order to receive the maximum possible sale price, which likely involves some amount of goodwill, the vendor will agree to finance part of the sale by allowing the buyer to pay a portion of the sale price over a defined period of time within a structured payment schedule. The vendor may also offer transition assistance for a period of time to make sure the transition period is seamless. The combination of support and financing by the vendor creates a positive vested interest whereby it is in the vendor's best interest to help the buyer successfully transition all aspects of ownership and operations.

Failure to do so could result in the vendor not getting all the proceeds of sale in the future in the event the business were to suffer or fail under new ownership. This is usually a very appealing aspect to potential lenders as the risk of loss due to transition is greatly reduced. This speaks directly to the next financing challenge.

Business Transition Risk Will the new owner be able to run the business as well as the previous owner? Will the customers still do business with the new owner? Did the previous owner possess a specific skill set that will be difficult to replicate or replace? Will the key employees remain with the company after the sale?

A lender must be confident that the business can successfully continue at no worse than the current level of performance. There usually needs to be a buffer built into the financial projections for changeover lags that can occur. At the same time, many buyers will purchase a business because they believe there is substantial growth available which they think they can take advantage of. The key is convincing the lender of the growth potential and your ability to achieve superior results.

Asset Sale Versus Share Sale For tax purposes, many sellers want to sell the shares of their business. However, by doing so, any outstanding and potential future liability related to the going concern business will fall at the feet of the buyer unless otherwise indicated in the purchase and sale agreement. Because potential business liability is a difficult thing to evaluate, there can be a higher perceived risk when considering a small business acquisition loan application related to a share purchase.

Market Risk Is the business in a growing, mature, or declining market segment? How does the business fit into the competitive dynamics of the market and will a change in control strengthen or weaken its competitive position? A lender needs to 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, a sustained cash flow will obviously allow a smoother process of repayment. Second, a strong going concern business has a higher probability of resale.

If an unforeseen event causes the owner to no longer be able to carry on the business, the lender will have confidence that the business can still generate enough profit from resale to retire the outstanding debt. Localized markets are much easier for a lender or investor to assess than a business selling to a broader geographic reach. Area based lenders may also have some working knowledge of the particular business and how prominent it is in the local market.

Personal Net Worth Most business acquisition loans require the buyer to be able to invest at least a third of the total purchase price in cash with a remaining tangible net worth at least equal to the remaining value of the loan. Statistics show that over leveraged companies are more prone to suffer financial duress and default on their business acquisition loan commitments. The larger the amount of the business acquisition loan required, the more likely the probability of default.