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by Tom West
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The epidemic of corporate downsizing in the
U.S. has made owning a business a more
attractive proposition than ever before. As
increasing numbers of prospective buyers embark
on the process of becoming independent business
owners, many of them voice a common concern: how
do I finance the acquisition?
Prospective buyers are aware that any credit
crunch prevents the traditional lending
institution from being the likely solution to
their needs. Where then, can buyers turn for
help with what is likely to be the largest
single investment of their lives? There are a
variety of financing sources, and buyers can
find one that fills their particular
requirements. (Small businesses--those priced
under $100,000 to $150,000--will usually depend
on seller financing as the chief source.) For
many businesses, the following are the best
routes to follow:
Buyer's Personal Equity
In most business acquisition situations, this
is the place to begin. Typically, anywhere from
20 to 50 percent of cash needed to purchase a
business comes from the buyer and his or her
family. Buyers should decide how much capital
they are able to risk, and the actual amount
will vary, of course, depending on the specific
business and the terms of the sale. But, on
average, a buyer should be prepared to come up
with something between $25,000 to $150,000.
The dream of buying a business by means of a
highly-leveraged transaction (one requiring
minimum cash) must remain a dream and not a
reality for most buyers. The exceptions are
those buyers who have special talents or skills
sought after by investors, those whose business
will directly benefit jobs that are of local
public interest, or those whose businesses are
expected to make unusually large profits.
One of the major reasons personal equity
financing is a good starting point is that
buyers who invest their own capital start the
ball rolling--they are positively influencing
other possible investors or lenders to
participate.
Seller Financing
One of the simplest--and best--ways to
finance the acquisition of a business is to work
hand-in-hand with the seller. The seller's
willingness to participate will be influenced by
his or her own requirements: tax considerations
as well as cash needs.
In some instances, sellers are virtually
forced to finance the sale of their own business
in order to keep the deal from falling through.
Many sellers, however, actively prefer to do the
financing themselves. Doing so not only can
increase the chances for a successful sale, but
can also be helpful in obtaining the best
possible price.
The terms offered by sellers are usually more
flexible and more agreeable to the buyer than
those from a third-party lender. Sellers will
typically finance 30 to 50 percent--or more--of
the selling price, with an interest rate below
current bank rates and with a far longer
amortization. The terms will usually have
scheduled payments similar to conventional
loans; the tax picture, however, can be better
than with straight debt.
As with buyer-equity financing, seller
financing can make the business more attractive
and viable to other lenders. In fact, sometimes
outside lenders will refuse to participate
unless a large chunk of seller financing is
already in place.
Venture Capital
Venture capitalists have become more eager
players in the financing of independent
businesses. Previously known for going after the
high-risk, high-profile brand-new business, they
are becoming increasingly interested in
established, existing entities.
This is not to say that outside equity
investors are lining up outside the buyer's
door, especially if the buyer is counting on a
single investor to take on this kind of risk.
Professional venture capitalists will be less
daunted by risk; however, they will likely want
majority control and will expect to make at
least 30 percent annual rate of return on their
investment.
Small Business Administration
Thanks to the U.S. Small Business
Administration Loan Guarantee Program, favorable
financing terms are available to business
buyers. Similar to the terms of typical seller
financing, SBA loans have long amortization
periods (ten years), and up to 70 percent
financing (more than usually available with the
seller-financed sale).
SBA loans are not, however, a given. The
buyer seeking the loan must prove stability of
the business and must also be prepared to offer
collateral--machinery, equipment, or real
estate. In addition, there must be evidence of a
healthy cash flow in order to insure that loan
payments can be made. In cases where there is
adequate cash flow but insufficient collateral,
the buyer may have to offer personal collateral,
such as his or her house or other property.
Over the years, the SBA has become more in
tune with small business financing. It now has a
Lo-Doc program for loans under $100,000 that
requires only a minimum of paperwork. Another
optimistic financing sign: more banks are now
being approved as SBA lenders.
Lending Institutions
Banks and other lending agencies provide
unsecured loans commensurate with the cash
available for servicing the debt. ("Unsecured"
is a misleading term, because banks and other
lenders of this type will aim to secure their
loans if the collateral exists.) Those seeking
bank loans will have more success if they have a
large net worth, liquid assets, or a reliable
source of income. Unsecured loans are also
easier to come by if the buyer is already a
favored customer or one qualifying for the SBA
loan program.
When a bank participates in financing a
business sale, it will typically finance 50 to
75 percent of the real estate value, 75 to 90
percent of new equipment value, or 50 percent of
inventory. The only intangible assets attractive
to banks are accounts receivable, which they
will finance from 80 to 90 percent.
Although the terms may sound attractive, most
business buyers are unwise to look toward
conventional lending institutions to finance
their acquisition. By some estimates, the rate
of rejection by banks for business acquisition
loans can go higher than 80 percent.
With any of the acquisition financing
options, buyers must be open to creative
solutions, and they must be willing to take some
risks. Whether the route finally chosen is
personal, seller, or third-party financing, the
well-informed buyer can feel confident that
there is a solution to that big acquisition
question. Financing, in some form, does exist
out there.
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