Economics For Expansion: The Ins and Outs of Business Acquisition Financing

Posted On February 11, 2020

If you’re looking into the possibility of acquiring a business, the chances are that things are going well for your endeavour. Taking on a new business to bolster your portfolio is a key indicator of ambition and progress. It could also help to skyrocket your revenue. 

Acquisition financing relates to the capital that’s obtained in order to buy another business. This particular form of financing enables owners to take action on their business aspirations by providing the necessary windfall to stage a transaction. 

But how does business acquisition financing work? And what methods of financing could owners take in order to buy an existing business? Let’s take a deeper look at the ins and outs of business acquisition financing: 

How acquisition financing works

Acquisitions

(Value of acquisitions worldwide from 1985 – 2018 in billion $. Image: Statista

There is no shortage of options available to business owners when it comes to acquisition financing. The most common choice comes in the form of credit or traditional loan structures. There are relatively good repayment rates available for businesses that are ready to expand, which go some way in easing the burden of integrating a brand new business into your operations. 

There are plenty of loans available through most traditional banks, and specialised lending services can also cater to this particular form of finance. If your company, for whatever reason, is refused an acquisition loan from a bank, private lenders could potentially spring to your rescue and offer funding – albeit with higher accompanying interest rates

If your business has demonstrated that it’s capable of regularly generating a healthy stream of revenue, the world of acquisition financing will likely be your oyster, and you’ll have plenty of choices available when it comes to taking the next step of expansion through buying a business. 

Let’s take a closer look at the type of acquisition financing options available to business owners:

Bootstrapping

Naturally, the most cost-effective way of financing a business acquisition is to do so using your own generated revenue. While the term ‘bootstrapping’ may not be synonymous with a company successful enough to start buying out other businesses, there will likely be some form of cutbacks in your operations to ensure that you’re well-positioned to make such a significant financial commitment. 

This form of funding can take into account your savings, retirement accounts and equity on your assets. However, it’s unlikely that you’ll be looking to buy a business using your own funds alone, and it’s much more common that buyers will combine their assets with seller financing or a business loan along the way. These alternative forms of financing can enable business owners to acquire larger companies with more confidence. 

Seller financing

Seller financing is a common way of funding an acquisition. This fundamentally involves asking the seller to come up with the financing in the form of a loan that’s amortised over a period of time. Here, you’ll pay the loan back with the revenue generated by the business. This method provides a more conventional, flexible financing model – while also offering a vested interest for the seller to provide accurate information regarding their business’ performance. 

Sellers are typically willing to fund between 30% and 60% of the agreed sale price, with very few agreeing to fund more. This form of financing can ultimately be cheaper for the buyer, but expect the seller to perform a higher level of due diligence on you. So in this case, it’s important to have your books in order, with credit, assets, experience and viability of your business plan set to come under scrutiny. 

Equity funding

Equity funding follows a similar format to Dragon’s Den. Here, you approach investors with a proposition, and if they like what they hear they will generally offer you money in exchange for a share of the business that you’re set to buy. 

This option is a solid way of gaining the industry experience and guidance of an investor but comes at the cost of equity – meaning that the business you buy won’t belong to you in its entirety. 

Bank loan

Conventional bank loans are another common way of funding an acquisition. However, for some businesses, it can be difficult to access money in this manner. This is because banks tend to lend funds against existing assets as opposed to business plans – meaning to get a loan, you’ll need substantial assets, strong credit records, and a healthy industry track record.

Due to the trickiness of acquiring finance in this way, some newer businesses choose to get a bank loan guaranteed by the Small Business Administration – which can inject up to $5 million in credit into your company, provided the business has a good credit record and can show three years of tax information

Leveraged buyout

Leveraged buyouts make one of the more shrewd and popular acquisition financing options available to owners. This approach helps to enable buyers to maximise their returns while minimising the money they invest. 

While the notion of leveraging your assets can boost your returns, if you fail to turn profits in with your newly acquired business, it could carry dire consequences for your losses. 

The structure behind leveraged buyouts is a simple one. Users leverage some of their existing business assets, like equipment, property or inventory in order to fund the acquisition. This method can work in tandem with business loans or seller financing to help ease an approach’s financial burden. 

Venture capital 

It can be a little bit tricky attracting the interest of venture capitalists at the best of times, but if you’re capable of showcasing a strong USP while demonstrating a potential for higher returns then it’s possible that you can draw funding from willing investors. 

This method can be particularly useful to entrepreneurs with a proven track record when it comes to business ownership. To gain investment from a venture capital source is a great way of drawing on some added industry experience from somebody who will have a vested interest in your endeavour. However, venture capital funding typically comes at the cost of some level of equity in your business, so it’s important to assess your options with this in mind. 

Angels

Angel investors are hard to come by, but can make for the perfect avenue to access enough of a windfall to acquire a company. Angels typically focus on financing the early stages of a business’ lifecycle, so can be ideal when it comes to buying a company. 

Many angels are also capable of offering up strategic advice, and will likely offer funding because of a genuine mutual interest and background into the industry in which you’re looking to expand. 

It can be difficult to access money through angel investors, but their expertise will certainly prove helpful even if they decide against parting with their money. To help you to identify where to look when accessing this form of funding, angels tend to focus their attentions towards local endeavours and nearby business networks. 

However you choose to fund a business acquisition, be sure to keep away from hasty movements and always perform enough risk assessments to help you to act with confidence. Buying a new business can be the first step towards market dominance, but if you’re unable to see clear potential in your cash flow forecasts, make sure you exercise caution before taking the plunge.

Written by Daglar Cizmeci
Investor, Founder and CEO with over 20 years’ industry experience in aviation, logistics, finance and tech. Chairman at ACT Airlines, myTechnic and Mesmerise VR. CEO at Red Carpet Capital and Eastern Harmony. Co-Founder of Marsfields, ARQ and Repeat App.

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