Loans

Business Acquisition Loans Explained (2023)

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Whether you’re an entrepreneur eyeing a takeover or an established company seeking to acquire an asset or diversify its portfolio, understanding the intricacies of business acquisition loans can be a game-changer.

In the business world, growth and expansion often necessitate strategic maneuvers, and one such vital tool is the business acquisition loan. So what is a business acquisition loan? Below, we will take a look at the concepts surrounding business acquisition loans, explain how they work and shed light on the various types that cater to a wide spectrum of acquisition strategies. Whether you’re new to the world of finance or a seasoned industry player, this comprehensive guide will equip you with the knowledge needed to navigate the landscape of business acquisition financing.

What Is an Acquisition Loan?

An acquisition loan serves as a financial lifeline for businesses seeking to procure valuable assets or even entire companies, bridging the gap when their liquid capital falls short. This type of loan often offers more favorable terms, primarily because it is secured by the tangible value of the assets being acquired, as opposed to funds earmarked for daily operations or product launches. The key advantage lies in the asset itself, which serves as collateral; should the borrower default on the loan, the lender can seize and liquidate the acquired asset to recoup the unpaid portion of the loan.

However, an acquisition loan operates within a defined time frame and a predetermined purpose, setting it apart from a traditional line of credit. Once approved, the loan must be utilized for the specified purpose within the allotted time, and once the repayment schedule is completed, no additional funds remain accessible.

Moreover, acquisition loans are not limited to acquiring standalone assets; they can also facilitate the purchase of entire companies. In such cases, the acquiring entity must assess whether the assets of the target company provide sufficient collateral to cover the loan required for acquisition. Additionally, it’s imperative to evaluate whether the merged businesses can generate adequate cash flow to service the loan, encompassing both principal and interest. For larger and more intricate acquisitions, collaboration between investment banks, law firms, and third-party accountants is often necessary to ensure the loan’s precise structuring and execution.

Types of Business Acquisition Loans

Acquisition loans for businesses are diverse, with no single, one-size-fits-all option. Instead, a variety of business loan categories are available to facilitate the acquisition of other companies. These encompass term loans, lines of credit, government-guaranteed loans, and more. Each loan type offers distinct advantages tailored to specific circumstances, but it’s essential to note that not all options are universally suitable for every organization.

SBA Loans:

SBA loans, backed in part by the federal government, stand as a robust resource for businesses seeking financial support. These loans, often sporting favorable interest rates, provide a lifeline for business owners with less-than-ideal credit, enabling them to finance ventures with as little as a 10% down payment. The federal government’s partial guarantee mitigates lenders’ risk, reducing your liability in case of default, albeit accompanied by an additional fee.

SBA loans exhibit remarkable flexibility, catering to diverse acquisition needs. In some instances, loan terms extend up to an impressive 25 years.

Term Loans:

In the realm of non-SBA business acquisition financing, traditional term loans take center stage. Widely accessible through a multitude of online lenders, banks, and credit unions, term loans furnish borrowers with a fixed sum disbursed upfront, to be repaid through predetermined installments over the loan’s duration. Unlike revolving lines of credit, term loans offer a one-time injection of funds.

Interest rates for term loans may be variable or fixed, and those with solid credit profiles may secure rates even more competitive than SBA offerings. Typically, term loans require collateral, accompanied by a personal guarantee holding borrowers accountable should the business falter.

Lenders’ specific requirements for term loans vary, encompassing criteria like profitability thresholds and operational history ranging from several months to several years.

Startup Loans:

For aspiring entrepreneurs eyeing business acquisitions without an existing enterprise, startup loans come into play. Offered by conventional banks, the SBA, and other lenders, these loans necessitate demonstrating the requisite skills and capacity to operate a business. A down payment might also be mandatory as part of the approval process.

Equipment Financing:

Equipment financing is tailored to facilitate the acquisition of essential business equipment. A notable advantage is that the equipment itself serves as collateral, eliminating the need for additional security. In the event of default, the lender can claim ownership of the equipment. However, this financing type primarily suits businesses seeking to cover the costs associated with purchasing equipment.

For those venturing into businesses with significant intellectual property or premade inventory, equipment financing may not align with their acquisition needs.

Business Lines of Credit:

While not the conventional choice for acquisition loans, business lines of credit can be a strategic option in specific scenarios. These revolving loans grant borrowers access to a predetermined credit limit, enabling withdrawals as needed during a defined draw period. Interest accrues only on the borrowed amount, with flexible repayment options.

Upon draw period conclusion, a business line of credit can often be converted into a structured loan with fixed monthly payments, facilitating gradual repayment over several years.

Revenue-Based Loans:

Revenue-based loans introduce a unique payment structure based on a percentage of monthly revenue, rather than fixed amounts. Borrowers receive an upfront lump sum, and repayments are determined as a portion of business revenue, inclusive of interest—a system akin to a merchant cash advance.

While revenue-based loans typically carry higher interest rates due to their variable repayment structure, they offer greater flexibility, with payments adjusting in line with monthly business performance, reducing the risk of default during slower periods.

How To Qualify?

Eligibility for an acquisition loan closely mirrors the criteria for obtaining any small business loan. To qualify, first pinpoint your funding requirement, or if you’re in the preliminary stages of identifying an acquisition target, determine your potential financing needs.

Once your funding purpose is clear, select the financing type that aligns with your business’s circumstances. Afterward, seek out a lender with expertise in that specific financing category.

The application process follows, demanding the completion of various forms and the submission of supporting documentation. Be prepared to address any inquiries posed by the loan officer pertaining to your business or the intended use of the loan.

Lenders rely on several crucial criteria when evaluating your suitability for an acquisition loan:

  1. Your business credit report (if established) and credit checks for any partners owning 20% or more of the company will be scrutinized. Minimum credit score requirements vary by loan type, with SBA loans, for example, typically requiring a minimum score of 640.
  2. Lenders assess your company’s financial health to ensure that your current or projected revenue can cover the loan payments. Most lenders seek a debt service coverage ratio of 1.25 times or higher, where your revenue divided by your debt service must exceed 1.25.
  3. Minimum down payment expectations fluctuate according to loan type. Certain loan types, like lines of credit, may not necessitate a down payment.
  4. Lenders require a comprehensive understanding of why you are seeking financing, whether it’s for facility acquisition, company purchase, or equipment procurement. They assess the asset’s value, its impact on your business’s profitability, and whether it constitutes a sound business decision.

It’s important to recognize that not every small business will meet the criteria for acquiring substantial assets or another company. Some businesses may lack the revenue necessary to meet loan repayment obligations, while others might grapple with prior credit issues that need resolution before loan approval. In cases where loan applications are declined, alternative financing avenues such as securing a co-signer or raising equity capital may still enable acquisitions to move forward.

Verdict

When considering the acquisition of a business or franchise, you’ll encounter a plethora of financing alternatives. During your evaluation, it’s crucial to examine all relevant aspects, such as loan repayment rates, terms, fund utilization constraints, APR, and beyond. Keep in mind that your objective goes beyond merely meeting the minimum loan prerequisites; your aim is to secure financing that aligns perfectly with your specific needs and objectives.