Finding the Perfect Fit - How to Pay For a Business Acquisition
According to the most recent M&A Trend Report from Deloitte, 2018 is shaping up to be a very active year in the world of business acquisitions. While large corporations are gearing up for increased activity, the lower and middle-market companies are also experiencing a more vibrant transactional environment.
Inevitably, the first question we get at Clover Capital when working with a client who is looking to buy (or sell) a business always revolves around the financing of the purchase.
The following are general guidelines of various scenarios, although all business transactions are open to negotiations and adjustments.
1. Seller financing
In many ways, this is the simplest form of financing a business purchase. The buyer pays a cash down payment to the seller, and the seller, acting like a bank, finances the remainder of the purchase, with payments made to the seller over time. The down payment in this case is purely negotiable. I tell buyers that it can be as much as 50 percent down, but ultimately it is whatever is agreeable between the buyer and the seller.
The remaining amount to be paid to the seller can simply be in the form of a promissory note with equal payments for a set period, or an earn-out, where payments are tied to performance of the business going forward. Either way, this benefits the buyer because the seller has a strong interest in seeing the business succeed under the new ownership. Seller financing is a flexible option, because terms are fully negotiable between buyer and seller. It can also be the fastest route to a closing.
2. Bank financing
In purchasing a small business, you are buying a cash flow stream more than you are buying hard assets. Because of this, business acquisitions are more suited for an SBA 7a business acquisition loan than they are for conventional financing. The SBA 7a is a government insured loan made by a private bank. The program is in place to encourage banks to lend in situations where physical assets might be minimal.
A typical structure is a 20 percent down payment from the buyer, a 10 percent carry (seller note) from the seller, with the bank contributing 70 percent paid to the seller at closing. **New SBA guidelines have created even more advantageous financing scenarios where the buyer only has to come in with 5% of the purchase price!** This is a good way for the buyer to leverage their capital and for the seller to get as much cash at closing as possible. Certain terms are dictated by the SBA, so there is less flexibility to how the buyer and seller structure the deal.
3. Alternative options
In situations where asset value is close to the purchase price, conventional bank loans and equipment financing can be viable options. In this case, the buyer borrows money from the bank with the assets as collateral, then the buyer pays the money to the seller.
Generally speaking, when we meet with a buyer, we tell them to anticipate putting 10 to 50 percent of the purchase price as a down payment. This gives them a realistic parameter to keep in mind as they are searching listing sites and looking for their next opportunity. Remember the various finance options and that all business transactions are open to negotiations and adjustments.
To learn more, visit www.clovercapital.org or email jr.clovercapital@gmail.com.