How Do Best Acquisition Loans Work? 2022

How Do Acquisition Loans Work?

Acquisition loans are loans that businesses use to acquire other businesses or strategic assets, such as equipment. These are purchases that typically cannot be made using the company’s normal cash flow, so businesses use loans to make purchases without raising capital. Using an acquisition loans, your company can make a large strategic purchase with as little as 15% down, then pay off the rest over time.

 

Acquisition loans are extremely common for companies that are growing rapidly as well as those that are actively engaged in mergers and acquisitions. It is also sometimes used by companies that use large or expensive equipment, such as construction companies, data storage providers, or large contractors. Acquisition loans help these businesses acquire critical assets (including other companies) that can help them grow their bottom lines.

What is an acquisition loan?

An acquisition loans is a loan that businesses use to acquire an asset or another company. Some (but not all) acquisition loans are used when the assets being acquired will be collateral for the loan – this is particularly helpful when your business does not have enough value to secure the loan with separate assets.

Most acquisition loans require you to provide a down payment to fund the acquisition portion. SBA loans, for example, require as little as 15% of the total transaction value as a down payment (also known as “equity injection”). Depending on your business, the type of loan and the property you are buying, the lender may require a down payment of 20% to 30% of the total transaction.

Small Business Administration (SBA) loan

SBA loans are business loans that are partially guaranteed by the federal government. The SBA offers multiple loan programs, but most SBA loans are term loans. These loans often offer the best interest rates available to business owners who don’t have ideal credit and allow them to finance transactions with as little as 10% down.

Also, with an SBA loan, part of the loan is guaranteed by the federal government, and this limits your liability if you later default—though there is also an additional fee of several percentage points of the amount guaranteed.

SBA loans are generally quite flexible and can be used for a wide variety of acquisitions. For certain types of purchases, loan terms can last up to 25 years.

Conventional term loan

A traditional business term loan is one that a business can get through a bank or other traditional lender. These loans typically offer the best terms available – including the lowest interest rates – to qualified borrowers.

However, this loan is probably the most difficult to qualify for. This makes them ideal if you have excellent credit and plenty of free cash flow to service your business loan – even if you have established banking relationships with lenders that offer this type of financing.

In addition to the lowest interest rates, traditional business term loans typically offer some of the lowest fees available, as they do not charge the guarantee fees that SBA loans do.

Startup Loans

While most commercial loans require businesses to be in operation for at least a year or two, startup loans are better for companies that are still getting off the ground. These loans typically have a streamlined application process—even through the SBA—because there isn’t as much information to review about the company’s finances. Fees can also be low, as most startups don’t have the funds to pay huge fees.

Startup loans are riskier for lenders than many other types of business loans, so interest rates may be higher than traditional term loans or business lines of credit, but rates are still lower than those charged by business credit cards.

Another thing to note about startup loans is that some programs limit borrowers to lower amounts than are available through other loan programs, although the limit for SBA startup loans through the agency’s 7(a) program is $5 million. Depending on which program you use, this may limit the size of the edit you can complete. But this can be prudent, as many companies that are just starting out have not established the cash flow necessary to support large loan balances.

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Business lines of credit

Business lines of credit (BLOCs) are not often used as acquisition loans, but can be ideal for that purpose in certain circumstances. These loans are revolving, meaning once you’ve been approved for a certain amount (your credit limit), you can borrow that money anytime during your draw period.

Once you draw against your line, you only pay interest on the money you actually borrowed (monthly interest-only payments), and you can pay off your balance as you choose. If you pay off your line within your draw period, you can borrow those funds again without going through another application process.

Interest rates for business lines of credit are usually slightly higher than fixed term loan rates, but you get a lot more flexibility with a BLOC than a term loan.

Once your draw period is over, your line of credit can usually be converted to a structured loan with fixed monthly payments, so you can pay off the balance over several years.

How do you qualify for an acquisition loan?

Qualifying for an acquisition loans is largely the same as qualifying for any small business loan. You need to identify a funding need (or potential funding need, if you’re trying to line up financing before identifying a target asset to acquire).

Once you know your reason for borrowing, you need to choose the right type of funding for your business circumstances, and then choose a lender that specializes in that type of financing. For example, if you want to get an SBA loan to buy a new facility, you should choose a bank or loan broker that has underwritten and approved many SBA loans.

After that, you need to go through the application process. This requires filling out a number of forms, as well as providing supporting documents and answering any questions the loan officer may ask about your business or the purpose of the loan.

These are some of the key criteria that lenders use to decide whether to approve you for an acquisition loan:

Credit: A lender will look at your business credit report (if your business has established credit) and run a credit check on you and any partners who own 20% or more of your company. The minimum credit score varies by loan type (640 is the minimum for an SBA loan).

Income: Lenders will examine your company’s finances to ensure that your current or projected income will support the payments required to service the loan. Most lenders look for a debt service coverage ratio of 1.25 times or higher (your income divided by your debt service must be greater than or equal to 1.25).

Down Payment: The minimum down payment varies according to the type of loan. Most loans start at 10% to 15% of the total transaction, but payments can be higher depending on your credit profile, business cash flow, etc. Some loans, including lines of credit, do not have down payment requirements.

Use of funds: Lenders will need to know why you are requesting the loan (whether you are buying a facility, company or equipment), the value of the asset you want to buy, how it will affect profitability. Your business, and whether it represents a good business decision.

Not every small business will qualify for a loan to acquire large assets or another company. Some businesses do not have enough revenue to repay the loan. In other cases, individual business owners may have prior credit issues that need to be cleared up before they can receive a loan. If your loan application is denied, you may still be able to finance the acquisition, but you may need a co-signer or raise equity capital instead.

What are the benefits of a business acquisition loan?

Using an acquisition loans to make a large purchase can have many benefits. This may vary depending on the circumstances of your business, as well as the type of loan and terms offered by the lender.

Some of the common advantages of this acquisition loans are:

• They reduce the amount of capital your business must use to complete the acquisition.
• They allow you to make your edits and pay them off over time.
• They help you build business credit.
• If used properly, they help your business grow its bottom line.
• The loan may be based on your projected income (after acquisition) rather than current sales.

Acquisition loans are not always ideal. In many cases, businesses may not even qualify to use them. But, for those who qualify and when used properly, business acquisition loans can be very beneficial in many situations.

Advantages of Business Acquisition Loans

There are several unique benefits that come with a small business loan, including:

It can be used to finance parts of the business that are not secured by collateral. In many cases, banks secure Acquisition loans with collateral such as real estate, inventory or equipment to reduce their financial risk. Types of business acquisition loans that do this include some short- and long-term loans and equipment loans. The popular SBA 7(a) loan does not require these assets, so if you don’t have them, that’s okay. You may be buying intellectual property rather than physical property, which is where a business acquisition loan can help. You can get up to $25,000 with this loan without the need for collateral. We will discuss this further below.

It is a long-term solution that can help you through the crucial early years. While short-term financing options are available (including short-term loans), there are more long-term options available, including long-term loans, equipment loans, and 7(a) loans from the SBA. Some business acquisition loans from the SBA are open revolving accounts based on usage, allowing businesses to access available funds during a set draw period.

There are also plenty of term Acquisition loans that let you decide whether you’d prefer a shorter or longer repayment schedule. SBA loans typically have a maximum maturity of 10 years for equipment, 10 years for working capital or inventory loans, and 25 years for real estate.

Turnaround time can be quick. Most business acquisition loans have a quick turnaround time, with some online lenders approving within 24 hours, giving you more flexibility. While some SBA loans can take weeks or even months to get, there are many other lenders that have faster turnaround times.

Disadvantages of Business Acquisition Loans

As with any loan, there may be some drawbacks to using a business acquisition loan to purchase a new business for yourself. Financing to buy an existing business is a complicated decision, so carefully consider these disadvantages of business acquisition loans.

Lenders rely more on cash flow and credit score. Any business acquisition loan (which can include 7(a) Acquisition loans and startup loans) that is not centered around collateral will focus more on cash flow and credit score. Lenders need to have more confidence in your ability to repay the loan. They will highly value your cash flow and personal credit score during the loan approval process, so for business owners struggling in either of these areas, obtaining this type of loan can be difficult.

Interest rate may increase. All types of business acquisition loans will come with interest rates, which can quickly eat into your bottom line. When you need startup capital to buy a business, you want to make sure the interest rate isn’t so high that it prevents you from being profitable or eats into the cash flow you need to grow your business. Interest rates can vary depending on the loan you are seeking and the lender you are considering.

Certain types of business acquisition loans may have conditions or restrictions. For example, a 7(a) SBA loan requires that the previous owner has not retained any equity in the business, and that you have exhausted other financing options before pursuing a 7(a) loan. Any term loan or equipment loan may require collateral to secure it, so you’ll want to do your research carefully to determine what will work best for you.

Learn business valuation

When applying for a business acquisition loan, you will be asked about the valuation of the business you want to acquire. Business valuation determines how much a company is worth.

Lenders look carefully at the business valuation for a business acquisition loan when evaluating how much loan to approve you. For example, a small, local business valued at only $15,000 may have a harder time convincing a lender to approve them for $350,000 than a brand with a valuation of $75,000 or more.

Business valuation is an important factor that lenders focus on during the approval process, as it also helps them assess their risk. The higher the business valuation, the less risky a higher loan amount becomes because there is a stronger chance that the lender will be repaid.

Business valuation can be calculated in different ways. The three most popular options are:

A market-based valuation, which compares your business to other similar companies in your industry. This approach works best when your services, prices and performance are standard for your industry.
Asset-based valuation, which looks at the net worth of a business’s assets. For example, a restaurant may have expensive kitchen appliances, shatter-resistant dishes, expensive booths and tables, and a large inventory of vintage wine. This approach can help lenders assess their risk in lending you money.

Income-based valuation, which focuses on how much cash flow your business is projected to generate in the future. While this is impossible to know for sure, a strong financial history along with an upward projection for income is a good sign for lenders.

Gather necessary financial documents

During the application process, you’ll need to submit a variety of financial documents. The requirements will vary from lender to lender, but these are common business acquisition loan requirements that you can expect to see from most lenders:

• The loan application form
• Two previous years of federal income tax returns for the business you’re planning on purchasing
• A current profit and loss (P&L) statement from the existing business
• A proposed Bill of Sale, which must include the Terms of Sale
• The asking price and the schedule of inventory, equipment and furniture
• Personal background and financial statement (many lenders require a statement of personal history and a personal financial statement)
• Projected financial statements, detailing a one-year income projection with a written explanation of how you plan to reach it
• Information about the business’s ownership and any affiliations
• Information about the business, including data for business certifications and licensing
• Your loan application history
• Your personal and business federal income tax returns from the previous three years
• A personal resume for each borrower
• A review of the business and its history, which should include an explanation of why the loan is needed and how you’ll utilize it

Choosing the best business acquisition loan

There are numerous financing options to choose from when you’re looking at acquiring a business or buying into a franchise. The conventional 7(a) SBA loan is a popular choice for many, but term loans and equipment financing can also be a good choice, depending on exactly what kind of business you’re acquiring and how you intend to use the funds. Startup Acquisition loans, on the other hand, are great for those trying to break into business ownership, particularly with newer entities that have potential for a lot of growth.

When assessing your options, make sure you look at all the factors involved, including loan repayment rates and terms, restrictions on how you can use the funds, APR and more. Remember that it’s not just about meeting the minimum loan requirements; you want to make sure that the financing works for your needs, too.