5 Key Components Of A Small Business Acquisition Loan
Major Challenges To Securing A Business Acquisition Loan
Qualifying for a small business acquisition loan can be quite an ordeal to say the least.
If the business being sold is very profitable, the selling price will likely reflect a significant amount of goodwill which can be very difficult to finance.
If the business being sold is not making money, lenders can be difficult to find even if the underlying assets being acquired are worth substantially more than the purchase price.
Business acquisition loans, or change of control financing situations, can be extremely varied from case to case.
That being said, here are the major challenges you'll typically have to overcome to secure a small business acquisition loan.
Financing Goodwill
The definition of goodwill is the sale price minus the resale or liquidation value of business assets after any debts owing on the assets are paid off.It represents the future profit the business is expected to generate beyond the current value of the assets.
Most lenders have no interest in financing goodwill.
This effectively increases the amount of the down payment required to complete the sale and/or the acquisition of some financing from the vendor in the form of a vendor loan.
Vendor support and Vendor loans are a very common elements in the sale of a small business.
If they are not initially present in the conditions of sale, you may want to ask the vendor if they would consider providing support and financing.
There are some excellent reasons why asking the question could be well worth your time.
In order to receive the maximum possible sale price, which likely involves some amount of goodwill, the vendor will agree to finance part of the sale by allowing the buyer to pay a portion of the sale price over a defined period of time within a structured payment schedule.
The vendor may also offer transition assistance for a period of time to make sure the transition period is seamless.
The combination of support and financing by the vendor creates a positive vested interest whereby it is in the vendor's best interest to help the buyer successfully transition all aspects of ownership and operations.
Failure to do so could result in the vendor not getting all the proceeds of sale in the future in the event the business were to suffer or fail under new ownership.
This is usually a very appealing aspect to potential lenders as the risk of loss due to transition is greatly reduced.
This speaks directly to the next financing challenge.
Business Transition Risk
Will the new owner be able to run the business as well as the previous owner?Will the customers still do business with the new owner?Did the previous owner possess a specific skill set that will be difficult to replicate or replace?Will the key employees remain with the company after the sale?
A lender must be confident that the business can successfully continue at no worse than the current level of performance.In general, there must be a buffer in the financial projections for any exchange rate lags that may arise.
At the same time, many buyers will buy a business believing there is significant growth that they believe can benefit from.
The key is to convince the lender of your potential for growth and your ability to produce superior results.
Selling assets versus selling shares
For tax reasons, many sellers want to sell their company's shares.
However, this means that all outstanding and potential future liabilities in connection with the going concern of the company fall at the feet of the buyer, unless otherwise specified in the purchase agreement.
Because potential corporate liability is somewhat difficult to assess, a higher risk may be perceived when considering a small business loan application in connection with the purchase of stocks.
Market risk
Is the company in a growing, mature or declining market segment? How does the business fit into the competitive dynamics of the market? Will a change of control strengthen or weaken your competitive position?
A lender must have confidence that the business will be successful for at least the period that the loan is outstanding to purchase the business.
This is important for two reasons: first, having sustained cash flow naturally allows for a smoother repayment process; Second, a strong company has a higher likelihood of reselling.
If an unforeseen event makes it impossible for the owner to continue the business, the lender has the assurance that the business can still generate sufficient proceeds from the sale to meet the outstanding debt.
Localized markets are much easier for a lender or investor to assess than a company selling to a wider geographic area.