{"id":25731,"date":"2022-12-21T11:49:11","date_gmt":"2022-12-21T11:49:11","guid":{"rendered":"https:\/\/swoopfunding.com\/ca\/?post_type=blog&p=25731"},"modified":"2025-02-18T14:32:07","modified_gmt":"2025-02-18T14:32:07","slug":"how-to-finance-a-business-acquisition","status":"publish","type":"blog","link":"https:\/\/swoopfunding.com\/ca\/acquire-a-business\/how-to-finance-a-business-acquisition\/","title":{"rendered":"How to finance a business acquisition"},"content":{"rendered":"\t\t
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Often, the purchaser of a business will give the seller a Letter of Intent<\/a> to purchase the business that is contingent on being able to secure financing. If you get to this step and you are not able to bootstrap the business financing all by yourself, there are a number of options available to you. For most buyers of existing businesses, the goal of financing is not only to acquire the business, but to make sure you have the flexibility and resources to grow.<\/span><\/p>

What is a business acquisition?<\/b><\/h2>

A business acquisition involves one person or entity purchasing a business from another person or entity. This could mean a single person buying a local restaurant franchise from somebody else, or a large manufacturing company taking over the operations and production facilities of a smaller competitor. Whether your deal is large or small, simple or complex, chances are it will require some type of outside financing.\u00a0<\/span><\/p>

How can I finance a business acquisition?<\/b><\/h2>

When considering how to buy a business, the simplest way is to fund it out of your own savings or to access personal borrowing facilities such as a home equity line of credit<\/a>. But for many business owners, these sources will not be enough. You may need to consider raising equity from investors or taking on some type of business loan<\/a>. These are the same basic options used by large enterprises when they make an acquisition.<\/span><\/p>

Acquisition finance<\/b><\/h3>

Many business acquisitions are financed by a combination of personal money, equity, and debt. Finding the optimal financing structure is important so you can have a smooth ownership transition and position your new company for growth while maintaining healthy personal finances in the process.<\/span><\/p>

Equity investment<\/b><\/h3>

Equity represents ownership in a business. Often, the owner and operator of a small business is also its first equity investor using his or her own savings. Another source of equity investment could be friends, family, or a professional private equity or venture capital firm. Generally, the more equity that is invested in acquiring a business, the less debt that will be required. For example, if you were able to raise $400,000 in equity to acquire a $1 million business, you would then need to borrow $600,000 to complete the transaction.<\/span><\/p>

Lenders like to see that the business owner and operator has an equity stake in the business. That means they\u2019ll have put their own capital at risk and have something of their own to lose. This usually signals to the lender that they have a stronger commitment that might contribute to a more successful business acquisition.<\/span><\/p>

Senior debt<\/b><\/h3>

Senior debt refers to the loan provided by the main lender. This loan is usually secured against the assets of the business, such as real estate, inventory, or equipment. The loan is called \u2018senior\u2019 because, in the event of the failure of the business, the senior lender has first call on those assets in order to recover their investment.<\/span><\/p>

The amount of money a senior lender will loan is often tied directly to the expected earnings of the business. This is typically expressed as a multiple of the company\u2019s earnings before interest, taxes, depreciation<\/a> and amortization<\/a>, or EBITDA.\u00a0<\/span><\/p>

For example, a lender might be willing to extend a loan equal to three times annual EBITDA. In the example above, where the business operator has $400,000 of equity and wishes to purchase a business for $1,000,000, the business would need annual EBITDA of $200,000 in order to qualify for a loan of $600,000.<\/span><\/p>

Most senior lenders will make loans with relatively strict terms, requiring monthly payments and other covenants, such as meeting certain ongoing financial performance criteria.<\/span><\/p>

Vendor financing<\/b><\/h3>

It\u2019s actually quite common for the seller of a business to provide some of the financing for its acquisition using what\u2019s called a vendor take-back or vendor note. These deals allow the person acquiring the business to pay the seller over a period of time with interest.<\/span><\/p>

For example, in the situation above, if the buyer of a $1 million business had $400,000 of equity and the business had enough earnings to qualify for a $400,000 loan from a senior lender, the buyer could bridge the final $200,000 of the purchase price using a vendor take-back.<\/span><\/p>

There are several potential advantages to this approach. Not the least of which is\u00a0 potentially a lower interest rate, more flexibility on the payback schedule, and a seller with a vested interest in a successful transition and the continued success of the business.\u00a0<\/span><\/p>

Mezzanine financing<\/b><\/h3>

Sometimes, even when a buyer lines up their equity, a senior lender and a vendor-take back, there is still a funding gap when attempting to acquire a business. This is where mezzanine financing<\/a> comes in. Because it\u2019s riskier debt for the lender, it generally comes with a higher interest rate. But, in exchange for that, it usually has very flexible repayment terms and can be a valuable part of your overall business financing package.<\/span><\/p>

How do I find the value of the business acquisition target?<\/b><\/h2>

Valuing a business can be more art than science, but there are a handful of factors that you should consider \u2014 ones that any equity or debt investor is likely to as well:<\/span><\/b><\/p>