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Exploring Diverse Avenues: Funding Options For Business Acquisitions

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Jeff Snell 01/25/2024

Acquiring a business can be a strategic move for entrepreneurs seeking growth, market expansion, or industry consolidation. However, one of the critical challenges in this endeavor is securing the necessary funds. In this article, we will delve into various means of funding a business acquisition, ranging from traditional financing to innovative alternatives.

  1. Bank Loans and Traditional Financing: Traditional bank loans remain a common avenue for funding business acquisitions. Entrepreneurs can approach banks for term loans, where the borrowed amount is repaid over a fixed period with interest. The approval process for bank loans typically involves a thorough examination of the borrower's creditworthiness, business plan, and collateral. From a practical perspective for Main Street business buyers, this route is virtually unheard of as banks view SBA guarantees as free insurance.

  2. SBA Loans: Only in rare cases does the SBA actually loan money. When the phrase "SBA loan" is referenced, it is usually referring to a commercial bank loan that has an SBA guarantee standing behind it. Small Business Administration (SBA) loans are a subset of bank loans that come with government backing, making them more accessible for small businesses. SBA loans require fees that can be rolled into the loan and are up to 3% higher than the prime rate (this is referred to as the spread and is how the bank earns income). On the positive side SBA guaranteed loans can be a faster route to closing than other paths and provide lower down payments, making them an attractive option for entrepreneurs looking to acquire businesses with limited capital.

  3. Seller Financing: Seller financing involves the business owner acting as the lender for a portion of the purchase price. A common myth is that the SBA required a component of seller financing. In fact, the SBA has never required seller financing. Some commercial lenders lending policies require seller financing in some instances - but it has never been an SBA "requirement". In this arrangement, the buyer makes payments to the seller over an agreed-upon period at an agreed-upon rate. This method is particularly useful when traditional financing is challenging to secure or when the seller has confidence in the business and buyer post-sale for the seller's tax planning purposes.

  4. Venture Capital and Private Equity: For businesses with high growth potential, venture capital and private equity firms can be valuable partners. These investors provide capital in exchange for equity ownership, and their involvement often brings strategic guidance and industry expertise. I refer to these investors as "professional money" and, as such, are interested in larger companies with management teams in place.

  5. Angel Investors: Angel investors are individuals who invest their personal funds in startups or businesses. Also commonly referred to as "family and friends" they can play a crucial role in funding business acquisitions, especially for smaller enterprises. Angel investors may offer mentorship and connections in addition to financial support. Angel investors often partner with one another to mitigate risk and allow for larger transactions.

  6. Crowdfunding: In recent years, crowdfunding has emerged as a viable funding option for business acquisitions. Platforms like Kickstarter and Indiegogo allow entrepreneurs to present their acquisition plans to a wide audience, seeking small contributions from a large number of backers. This method is more suited for some businesses than others and experienced financial and legal counsel should be sought to minimize potential shareholder issues.

  7. Asset-Based Lending: Asset-based lending involves using the assets of the target company as collateral for a loan. This can include accounts receivable, inventory, and machinery. Asset-based loans provide flexibility and are often secured more quickly than traditional loans. However, asset-based lenders rarely loan 100% of the current asset value and do not often place any value on the goodwill of the company, requiring the buyer to identify other lending methods and/or provide a higher downpayment.

  8. Mezzanine Financing: Mezzanine financing is a hybrid of debt and equity financing. It involves a subordinated loan that is repaid after senior debts in case of bankruptcy. This option is suitable for businesses with strong cash flow and a proven track record. Because of the risk profile accepted by mezzanine lenders, the interest rate and terms can be extreme.

Funding a business acquisition requires careful consideration of various factors, including the size of the acquisition, the financial health of the target company, the cost of capital, terms, and the risk tolerance of the acquiring entrepreneur. By exploring a diverse range of funding options, businesses can tailor their financial strategy to align with their specific needs and goals, paving the way for successful acquisitions and sustainable growth.

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This blog was originally written by Jeff Snell, LMCBI, M&AMI, CM&AP, ABA. Jeff is the founder and principal broker of ENLIGN Business Brokers and Advisors (www.enlign.com) headquartered in Raleigh, NC which provides business brokerage and M&A transaction services to mainstreet and lower middle market business owners across the South East wishing to sell their businesses. He can be contacted at (919) 624-1124 or jsnell@enlign.com.