What to Know Before Getting a Business Acquisition Loan 2022

What to Know Before Getting a Business Acquisition Loan

Securing funding for business growth—perhaps to fuel a pending merger or acquisition, or perhaps to promote some other type of corporate growth strategy—is never an easy task. Why? Because the layers of bureaucracy, regulations that drive pencil demand, and legal issues related to financial transactions make it a time-consuming task that cannot be done during the lunch hour. If you are looking for financing to deal with the impending expenses of your company’s growth plans, a business acquisition loan can be a necessary tool.

What is a Business Acquisition Loan?

In simple terms, a business acquisition loan is money given to a company to purchase assets or acquire another business or for other business-related purposes. Loan terms almost always indicate that the funds can only be used for purposes agreed upon by the lender and borrower.

A business acquisition loan is used when a company does not have enough liquid capital to expand or acquire assets. In most cases, the company seeking the loan has assets of tangible value, which are usually used as collateral for the loan. In some cases, the assets being purchased are used as collateral. The loan must be approved, and the proceeds must be used for the intended purpose and within the time agreed upon in the terms of the loan.

Types of Business Acquisition Loans

Like every other type of financial instrument, there are different types of business acquisition loans. These include the following:

SBA Loans

The Small Business Administration (SBA) is a government agency that connects lenders with businesses to secure loans. Again, there are a wide variety of different types of SBA loans available, but 7(a) loans are best suited for companies looking for business acquisitions. Currently, up to $5 million per loan is available, and flexible terms allow up to 25 years for repayment. As with virtually every other type of loan, a strong income and excellent credit history are required.

Term Loan

A term loan is a more “standard” type of loan – a package with fixed installments required for the life of the loan. Like other loans, it can be fixed rate (the same interest rate throughout the loan) or variable rate (the rate can fluctuate and is usually based on the Federal Reserve’s prime interest rate). Most banks, credit unions and online lenders offer term loans; However, they must be secured, meaning you have to sign a personal guarantee, holding you liable for the balance if the business defaults on payments or goes bankrupt.

There are other types of loans available, including startup loans, which are geared toward starting new businesses. This loan is similar to a term loan; However, exemptions are often given, as they are for the purpose of starting a business. Additionally, there is the Rollover Loan for Business Startups (ROBS), which allows funds from retirement accounts to be used to secure the loan. However, both these options are strictly used for new business startups and not necessarily for business acquisition or M&A purposes.

Assessment and evaluation

The next step is to conduct both assessment and evaluation. Evaluation assesses whether the business meets the criteria outlined in the business strategy. If not already covered in the essentials and nice-to-haves, the evaluation should consider the business’s history, reputation, location, any legal or compliance issues, staffing resources and needs, and the market outlook.

Business valuation is the process of determining the fair market value of a business. It should be conducted by a certified and accredited business appraiser affiliated with a national accrediting association.

The two most important factors considered in business valuation are cash flow and risk. Cash flow can be expressed in many ways, most notably as earnings before interest, taxes, depreciation and amortization (EBITDA) or seller’s discretionary earnings (SDE). All businesses have some degree of risk due to market trends, reliance on vendor relationships, competition, legal exposure and other variables. A business valuation will include an analysis of the company’s risk and will be referred to as a discount rate or capitalization rate as a percentage.

Negotiations and Agreements

Armed with appraisal and appraisal information, the prospective buyer and seller will negotiate price and terms. Engage your trusted legal and financial advisors to draft a letter of intent: Both you and the seller will sign this letter of intent to ensure that there is agreement on the specifics of the purchase. Lenders require a copy of the signed letter of intent from the seller before committing to finance the project. The contents of the letter will vary depending on what the parties agree to but will typically include items such as:

• transaction structure
• Due diligence and expected timeline for deal negotiations
• Any escrow to secure seller’s reimbursement obligations
• Exclusivity to the potential buyer
• Access to personnel, books and records of the seller for the benefit of the buyer as part of its due diligence process
• SELLER’S KEY REPRESENTATIONS AND SCOPE OF WARRANTIES

Why Use Business Acquisition Loans in 2022?

You can start a business from scratch, but it will take time to make it successful if it gets there. You can work your way in with an existing business and hope you can get a share, but that day may never come, and you won’t expect a payoff when you do. That leaves one real choice: buy an existing business. Now, you have to figure out how to pay for it.

There are many options available to you as a buyer, but we will focus on the most popular and well-known tools for buying a business. Loans are a great way to get into business ownership, and can help someone get into business who might not otherwise be able to.

Business loans are complicated and come with a lot of work for a business owner. Whether it is a new business or an existing business, a loan application will require thorough and extensive documentation, and may include the borrower’s personal credit score, tax returns, and personal finances. The target business will also need to provide records such as financial statements and balance sheets before being approved for financing.

Types of Business Acquisition Loans

The term business acquisition loan includes a variety of loans, some of which are not actually used to purchase a business. In some cases, business acquisition loans can be used to support purchases along with things like equipment financing and business improvements.

Some of the most popular loan options include:

Conventional term loans

The most basic form of loan, term loans work almost like any other type of loan in the market today. When approved for a term loan, the borrower receives a lump sum to purchase the business and must repay the loan over time with interest.

Equipment

Although they are not used to buy a business directly, equipment loans are important because they support acquisitions and allow borrowers to improve newly acquired operations. Equipment purchased using the loan will generally be used as collateral for the loan.

SBA Loans

The Small Business Administration (SBA) is a federal agency that assists in issuing loans by insuring or supporting funding for borrowers. This means that the government is not directly issuing loans. The SBA guarantees the lender that the funds will be repaid if the borrower defaults. SBA loans typically have strict requirements on who can get them and what they can be used for, which can make them a less than ideal choice for some businesses.

Before applying

Before shopping for a loan, you have to make sure that your financial life is in order. Some of the documents and preparation you need before receiving a loan may include:

Personal Credit History Records – You will need a credit score of at least 650 before being considered for a loan, but a higher score is an indication of credit worthiness and is better in almost all cases. Good credit can also net you better loan terms and repayment terms than bad credit. If you find errors when reviewing your personal credit report, you will need to take steps to correct that information before applying for a loan.

Tax documents – Your lender will want to understand your history with taxes and income over the years in business or as an individual taxpayer.

Business Finance Documentation – A lender will need to see a top-to-bottom financial summary of the business you hope to buy. This will include profit and loss statements, records of all payables and receivables and other records related to legal settlements and human resources. This is not a complete list of documents you will need. Bank loans and other business financing will require documentation on the type of business, the purchase price on record, and you may need to exhaust other financing options before applying.

Also Read: How To Get A Best Loan To Buy A Business In 4 Steps

Where to get a business acquisition loan

Conventional lender

If you have a good credit score and have a reasonable down payment — at least 10 percent or more — a traditional bank or credit union may be your best bet for getting a good rate on a business acquisition loan. Traditional lenders such as banks are the most popular option for obtaining funding or loans for a business, and often have a variety of financial products available for business acquisitions and other purposes.

One thing to keep in mind for traditional lenders is that their loan funds are usually at least partially funded by their customers’ deposits, so they need to be very protective of those depositors. This means that the vetting and application process with the bank or credit union will be more rigorous when using an alternative lender. Banks may also have limits on the types of loans they can issue in a particular industry or for a particular business type, so it’s important to understand your lender’s policies before getting too deep into the application process.

An aspect of this verification is the ability to have a financial institution with roots in the community. If there’s a question or problem, you’ll have the ability to speak to someone, sometimes at a local branch, for a personalized customer service experience. Banks and lenders are also limited on the amount of interest they can charge and the terms or structure of the loan they have, so you can be assured that you are not entering into a predatory or unsecured lending situation.

Alternative Lender

Technology Online lenders and alternative lenders have exploded in recent years as technology and communication have grown. These lenders are often funded by private investors and have different rules than their more traditional counterparts. This may mean you can get approved with a lower credit score or with a smaller down payment. It may also mean that you will be able to get approved for a larger loan amount. Alternative lenders may not offer SBA Business Acquisition loans and may not have the same type of lending products that banks do.

Despite that flexibility, there are some downsides to alternative lenders. They are not bound by many rules, so they charge higher interest rates. They may also charge higher interest rates and require higher fees to help cover credit risk for people with lower credit scores.

Other options

You may also find other ways to finance the purchase of a business. Seller financing is an option, where the current owner finances all or part of the purchase price. You may have existing assets that can also be liquidated for purchase, such as retirement accounts or other established businesses for leverage.

Obtaining a business acquisition loan can be one of the most difficult and complex financial decisions of your business life, but the upside makes the hassle worth the work. Business Acquisition Loans can help you buy or take on a business that you otherwise wouldn’t have been able to, and can set you up for success faster than without them.

Advantages and Disadvantages of Business Acquisition Loans

As with every financial transaction, there are pros and cons to going down the road towards a business acquisition loan. These include the following:

Pros:

• Opportunity to grow business fast
• Longer repayment terms can mean more flexibility
• Collateral is not required
• Borrowers with excellent credit may be eligible for lower interest rates

Cons:

• Qualifying for this type of loan can be difficult
• A down payment on a loan is required in many cases
• Depending on some factors, you may not be eligible for the full amount requested
• A personal guarantee may be a condition for approval

How to Apply for a Business Acquisition Loan

Obviously, you’ll need to keep your ducks in a row when it comes to applying for a loan. Whether you’re working with the SBA or a direct lender, there are a number of things you’ll need. These include the following:

Business Valuation: The company that borrows money obviously needs to be worth something, so an impartial third party must provide documentation showing the business valuation. These financial statements will include things like bank statements, balance sheets, profit and loss statements and tax returns.

Letter of Intent: This is a letter written by the buyer and presented to the seller in an instance of M&A. It outlines the proposed terms of the deal, and usually includes a clause that allows the buyer to get out in the event of default on the loan.

Credit reports and scores: Although the lender will obtain those reports on their own, the borrower should take the time to make sure they are in order, and that there are no dings or other issues that could damage the credit report.

Business Acquisition Loan Requirements

Financial institutions consider a broad range of factors when reviewing business acquisition loan applications, regardless of loan types. Borrowers should familiarize themselves with the financial institution’s loan options and specific requirements.

Being prepared in advance and having all the necessary documents on hand can make the loan process less stressful. Below is some information available:

• Two to three years worth of business and personal bank statements
• Business and personal credit reports and scores – These will usually be pulled by the financial institution, but you should have and be familiar with current copies to confirm accuracy.
• Business and personal tax returns for the past three years
• Current 2-3 years of financial documentation showing balance sheet, profit and loss statement and cash flow statement for acquiring business.
• Business plan
• Post-acquisition sales projections
• Estimation of Current Debt Service Coverage Ratio

Next steps

Anyone considering acquiring a business or franchise is advised to investigate various financing options and weigh the pros and cons of each. Compare rates and payment terms. Understand the full scope of any requirements. It is also important to be

Very honest about one’s financial situation, business skills and ability to take up a business or franchise. A Seacoast expert can walk you through the application process and help match your needs with the right product and service.

For information about business acquisition loan options at Seacoast Bank, contact your local banker below.

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Chris Capel is a technology expert, author and trainer. For more than 25 years, he has worked in the publishing, advertising and consumer products industries.