Are Acquisition Loans a Good Choice for Your Business?

When one business chooses to purchase most (or all) or another business’s shares to take control of the assets, it is a business acquisition.

Businesses perform acquisitions for a variety of reasons; not only do they gain a greater share of the market, but they also can reduce their own outgoings, and offer new products to their target audience. Huge multi-million dollar deals make the press yearly, with corporations such as Disney acquiring the entertainment assets of 21st Century Fox for $52.4bn in December 2017 being a highly notable example.

Small to medium businesses, however, may not deal with sale amounts as high as that, but it doesn’t mean they don’t require external help should they choose to purchase another brand.

Enter the Acquisition Loan, and the possibilities it brings with it. Financing a business acquisition is no longer merely for the billion-dollar corporations.

What is an Acquisition Loan?

The Small Business Administration (SBA) offers a variety of loans for small business, but by far, the most common and the most popular is the SBA 7(a) loan. This loan offers up to an amazing $5million in working capital. What this means for your business is that whatever you are looking to finance, including the acquisition of another business, the SBA 7(a) loan program is one to apply for.

“Perhaps no loan is more sought-after than the SBA loan… When it comes to rates and terms, it’s hard to find a more favorable loan option.” Jared Hecht, CEO of Fundera.

 

In January 2018, the SBA made a number of changes to this particular loan, which not only increases the likelihood of a business being accepted, but it streamlines the application process. When once it was challenging to get business loans from the SBA, the modifications have been designed to appeal to a wider audience of business owners.

What’s more, there are specific changes which refer to acquisition loans. One such example is that the SBA has drastically reduced the equity requirements. What this means is that banks are now able to provide finance for up to 90% of the business deal. It also means that the business buyer only needs to provide 5% of the equity, which makes business acquisition much more accessible for a vast number of small business. It’s an incredible change from the previous 25%.

Additionally, these changes are designed to fuel and boost business growth. As the lending to small businesses continues to rise, this shows no signs of slowing down now the application process and the requirements are easier for all businesses to access. It’s predicted that due to this, many businesses who have previously decided against expansion will now have their turn to move forward.

How do You Qualify?
While company acquisitions are more accessible, there are, of course, still numerous requirements you need to consider and prove you have to qualify.

  • Personal Credit: As with any business loan (or even personal loan), you will need a high credit score. Credit scorers higher than 650 will be accepted. If yours is currently lower, you may need to work to increase it before applying.
  • Letter of Intent: Similar to a business plan, the business buyer needs to provide a signed letter of intent to the business seller. This letter needs to state very clearly the proposed terms of the acquisition.
    However, many business owners don’t like to approach a business they are interested in purchasing until they secure the necessary finance. But lenders will not provide terms until they see this letter. It’s a challenging situation, and there are no exceptions to this requirement. It is a must. One way to get around it is to ensure the letter includes a clause which states the offer is dependent on securing finance.
  • Down Payment: Much like a deposit for a residential home, a business needs to provide a down payment. This can range between 10% – 30% of the overall business price. By providing a higher down payment, however, a business proves to the lender that they are serious and committed to this acquisition.
  • Collateral: While having insufficient collateral isn’t an immediate rejection, lenders do look favorably upon businesses who can back their application with the right collateral.

Are Acquisition Loans Beneficial?

Businesses who wish to branch out, overtake their competition, and reach a new audience can achieve this and more by purchasing companies. But are company acquisitions truly beneficial? Both for and against can be argued, with a number of pros and cons. However, the main to consider are:

Pros:

  • Without the SBA 7(a) loan, it can be difficult for a small business to raise the amount of capital needed to purchase another business. Most lenders will not consider a loan lower than $30,000, and you will be repaying the amount in monthly installments. It makes it much easier to purchase a business of a higher value than before.
  • The SBA limits how much interest lenders can charge for repayments. The maximum is set between 2.25% to 4.75%, which means it’s much more affordable to repay.

Cons:

  • For a business who lacks the sufficient down payment requirements, it can mean that the acquisition of business is not possible. For every $100 you wish to borrow, you will need a down payment of $20/30. When you calculate how much this will be when taking into account the total cost of the business, it can significantly add up.
  • If your credit score is not above 680, you will not be eligible. What’s more, if you have ever been declared bankrupt, or had tax issues, you will not be eligible.
  • For brand new businesses, with owners who have little-to-no managerial experience, you will not be considered for the loan. In addition to the sufficient industry experience, you will also need to provide financial plans which clearly state your business intentions for the next five years.
  • Perhaps one of the most important cons is that there is no guarantee, even if you secure the adequate funding, that a) the owners will sell their business to you, and b) that it will be a profitable venture. It’s this one which you need to consider seriously before applying.

To Conclude

The recent changes to SBA loans have made it easier for small businesses to apply for acquisition loans. However, it is only half the battle. Financing a business acquisition may be possible if you meet the specific guidelines, but whether or not the venture will be one which boosts your revenue and profit remains to be seen. Choosing a company acquisition is a risk and one you need to consider very carefully before proceeding. It may not pay off the way you hope.