Qualifying for a small business acquisition loan can be a difficult process. If the business is lucrative, the sale price will almost certainly include a considerable amount of goodwill, which can be difficult to finance.
Even if the core assets being acquired are worth significantly more than the acquisition price, lenders can be tough to come by if the business being sold is not profitable.
Business acquisition loans, often known as change of control financing, vary greatly from case to case.
As a result, here are the main obstacles you’ll have to face in order to get a small business acquisition loan.
Investing in Goodwill
The sale price less the resale or liquidation value of business assets after any debts owed on the assets are paid off is the definition of goodwill. It shows the profit that the company is expected to make in the future, in addition to the existing worth of its assets.
The majority of lenders are unwilling to finance goodwill.
This effectively raises the amount of the down payment required to complete the sale and/or obtain some vendor financing in the form of a vendor loan. In the sale of a small business, vendor support and vendor loans are fairly prevalent. You might wish to ask the seller whether they would consider providing support and financing if they are not already included in the terms of sale.
There are several compelling reasons why you should consider asking the question. In order to obtain the highest possible sale price, which will almost certainly include some goodwill, the vendor will offer to finance part of the transaction by allowing the buyer to pay a portion of the purchase price over a set length of time on a pre-determined payment plan.
The vendor may also provide transition assistance for a period of time to ensure a smooth changeover.
The vendor’s mix of support and finance provides a positive vested interest, making it in the vendor’s best interests to assist the buyer in effectively transitioning all elements of ownership and operations. If the vendor fails to do so, the vendor may not get all of the selling revenues in the future if the business suffers or fails under new ownership.
This is usually a very tempting feature to potential lenders because it reduces the chance of loss due to changeover.
This is a direct reference to the upcoming funding challenge.
Risks of a Business Transition
Will the new owner be able to operate the company as efficiently as the old one? Will the new owner’s customers continue to do business with him? Is there a skill set that the prior owner possessed that will be tough to duplicate or replace? Will the company’s core workers stay on after the sale?
A lender must be confident that the firm can continue to achieve at or above its existing level of success. There should normally be a buffer included in financial calculations for possible transition lags.
At the same time, many purchasers will purchase a company because they believe there is significant growth potential that they can capitalize on.
The objective is to persuade the lender of your business’s potential for growth and your capacity to deliver exceptional results.
Asset Sales vs. Stock Sales
Many sellers seek to sell their company’s stock for tax reasons.
However, unless otherwise stated in the purchase and sale agreement, any outstanding and prospective future liabilities relating to the continuing concern business will fall on the buyer.
Because assessing prospective business liability is challenging, there may be a larger perceived risk when considering a small business acquisition loan for a share purchase.
Is the company in a market segment that is expanding, maturing, or declining? How does the company fit into the market’s competitive dynamics, and how will a change in control affect its competitive position?
A lender must be convinced that the business will be successful for at least the duration of the business acquisition loan.
This is significant for a few of reasons. For starters, a steady cash flow will make the payback procedure go more smoothly. Second, a solid going concern business is more likely to be resold.
If the owner is unable to continue operating the business due to an unanticipated event, the lender will be confident that the business can still earn enough profit from selling to pay off the debt.
A lender or investor can appraise a localized market far more easily than a company selling to a larger geographic area. Local lenders may also have some working knowledge of the company and how well it is known in the community.
Individual Net Worth
Most business acquisition loans require the buyer to be able to pay cash for at least a third of the total purchase price, with a tangible net worth at least equivalent to the loan’s remaining value.
Overleveraged businesses are more likely to face financial difficulties and default on their company acquisition loan agreements, according to statistics.
The greater the amount of the required business acquisition loan, the greater the risk of default.