Five Keys Components Of A Small Business Acquisition Loan

To secure a business acquisition loan, you must have knowledge about how to manage the key components of the purchase the lender will be interested in.

This article discusses 5 key components of a business purchase and some insight as to how to effectively manage them to secure financing.

Major Challenges To Securing A Business Acquisition Loan

There are challenges facing a small business acquisition loan. Suppose the business to be sold is very profitable, the selling price will likely reflect a significant amount of goodwill which can be very difficult to finance.

It is obvious that if a business is sold and such a business is not making profit, to get a lender could be challenging.

Even if the underlying assets being acquired are worth substantially more than the purchase price, there would still be a challenge.

Business acquisition loans or change of control financing situations could be applied. However, this could vary depending on the situation at hand.

The following are the major challenges that are typically encountered before one could triumph over a small business acquisition loan.

Financing Goodwill

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. And there are good reasons why asking the question is very important.

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 support and financing effort 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 was to suffer or fail at the expense of new ownership.

Very appealing aspect to potential lenders as the risk of loss because transition can all of a sudden reduced. This takes us to the next financing challenge

Business Transition Risk

The questions often ask are: 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?

If should be ascertained by a lender that the business can successfully continue at no worse than the current level of performance. There usually needs to be a buffer built into the financial projections for changeover lags that can take place.

Moreover, many buyers sometimes purchase a business because they believe there is substantial growth available which they think they can take advantage of.

The most important is learn how to convince the lender of the growth potential and your ability to achieve superior results.

Asset Sale versus Share Sale

For the purposes of tax, many sellers concluded to sell the shares of their business. However, by doing so, any outstanding and potential future liability related to the going concern business will fall at the feet of the buyer unless otherwise indicated in the purchase and sale agreement.

Because potential business liability is a difficult thing to evaluate, there can be a higher perceived risk when considering a small business acquisition loan application related to a share purchase.

Market Risk

To know what to do with the market risk, these questions should be answered: Is the business in a growing, mature, or declining market segment?  How does the business fit into the competitive dynamics of the market and will a change in control strengthen or weaken its competitive position?

A lender needs to be confident that the business can be successful for at least the period the business acquisition loan will be outstanding.

There are two reasons why the above is very important:

  1. A sustained cash flow will obviously allow a smoother process of repayment. 
  2. Second, a strong going concern business has a higher probability of resale.

Suppose there is an unforeseen occurrence because the owner is no longer able to carry on the business, the lender will have confidence that the business can still generate enough profit from resale to settle the outstanding debt.

Localized markets are much easier for a lender or investor to assess than a business selling to a broader geographic reach.  Area based lenders may also have some working knowledge of the particular business and how prominent it is in the local market.

Personal Net Worth

Most of the business acquisition loans require the buyer to be able to invest at least a third of the total purchase price in cash with a remaining tangible net worth at least equal to the remaining value of the loan.

Statistics reveals that over leveraged companies are more prone to suffer financial duress and default on their business acquisition loan commitments.

All in all, the larger the amount of the business acquisition loan required, the more likely the probability of default.

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