Acquisitions are hot in today's market, but few entrepreneurs know what it actually takes to close a deal and how affordable it really can be. Acquiring an already existing business is a great option for many entrepreneurs. If you already own a business, you could use an acquisition to grow your presence in your current industry or expand into new ones.
For entrepreneurs just starting out, it can be a great way to start with an already proven business plan. For example, my company and I recently helped a client who was looking to expand his bookkeeping firm into a larger entity. We found a similar bookkeeping firm and the CEO saw this as an ample opportunity for expansion. The acquisition was used to gain both experienced employees, and a larger book of clientele. This acquisition also expanded their footprint and helped them become a virtual firm, modernizing their business for the future.
All said, here are some of my top tips and tricks after a decade in the business, if you're looking to finance an acquisition of your own.
1. The SBA is your best option.
There is no other conventional loan product that allows for a 10 year fully amortizing loan, other than the SBA 7(a) when purchasing a non-real estate asset. You can get up to $5 million, but you can do bigger transactions than that with the SBA as a piece of it, ideally with the same bank.
2. The SBA is not your lender.
The SBA guarantees a certain percentage of the conventional loan for the bank. The SBA 7(a) program is an insurance policy for the lender, it protects the bank and limits their exposure on the loan.
A bank may tell you you're not qualified for an SBA loan or that your loan does not qualify for SBA lending, but this may or may not be true. Understand why they're coming to that conclusion and get a second opinion. The SBA has standard operating procedures that each bank must follow to make loans backed by the SBA, but the lender places their own requirements on top of this.
3. Seek SBA preferred lenders.
These lenders are well versed in the SBA loan process and can cut weeks off your time. They are more comfortable with deals that lack real estate or significant collateral.
4. Consider collateral requirements.
Acquisition deals typically lack real estate as collateral and banks usually don't want to carry the exposure that comes with acquiring the goodwill or cash flow of a business. The SBA focuses first and foremost on the cash flow of the business to finance the loan, not the liquidation of collateral.
That being said, all individuals with 20 percent or more ownership in the borrowing entity must personally guarantee the loan and be willing to pledge collateral. The lender will also take a lien on your home if the loan amount is over $350,000. States that are protected by the Homestead Act will not require the primary residence to be pledged as collateral.
5. Know the down payment requirements.
Payment requirements can be as little as 10 percent down and the seller can offer 5 percent of the required 10 percent down on a seller note, but it has to be on complete standby (no payments for the life of the loan).
6. Learn the terms.
SBA loans used to purchase non-real estate assets are offered as 10-year, zero pre-payment, term loans. If real estate is more than 51 percent of the total project cost, you could finance over 25 years. One-hundred percent financing is available if you are an existing owner in a business seeking to buy out your partner(s).
7. Consider the cash flow and performance of the business.
Businesses are usually offered on a multiple basis (3-4x the earnings). You want to see performance on a historical basis that lends enough support to that loan at about a 3x-4x multiplier. If lower than 3x, you're getting a good deal. If over 4x, cash flow is tighter and it becomes more challenging.
8. Don't quit your day job.
Without ongoing outside income, the bank will build in new owner compensation, which is often more than what the current owner is paying themselves. It is helpful if your partner or spouse has ongoing outside income, but they also have to personally guarantee the loan.