The appeal of accelerating growth by consolidating with another company is universal. Businesses of all sizes and in all industries consider mergers and acquisitions (M&As) as a means to achieve scale.
Business acquisition loans empower companies to expand, diversify, and enhance operational efficiency. They also present many complexities, both in acquisition opportunities and financing. As you evaluate a path forward, it’s important to find the right capital structure to ensure a smooth transition and unlock growth potential.
Powering Business Growth
When your business is positioned to scale or diversify operations, merging with or acquiring an existing business can streamline access to new markets, innovation, or even the purchase of new equipment and infrastructure. Business acquisition loans are pivotal to facilitating this transition (or ownership transfer) with working capital.
This type of financing is available for both mergers and acquisitions, although each process is distinct. In a merger, both companies consolidate operations and form a new joint entity. In an acquisition, the larger company absorbs the smaller company, which ceases to exist.
Genuine mergers are rare. Acquisitions are more common, with the larger company continuing operations under both companies' names. The smaller company no longer exists, and their valuable name is simply purchased in acquisition. One household name that has found strategic acquisitions to be very good for business is Disney. Through purchasing influential studios—including Pixar, Marvel, Lucasfilm, and 21st Century Fox—their portfolio has increased in scale, relevance, and profit.
Unlocking Expansion Avenues
When a business is poised for growth, you may have the capital to expand and acquire, but sinking all of your capital into the purchase could leave you in a difficult position with cash flow to manage ongoing operations. Business acquisition financing offers flexibility through liquid capital that enables:
- Expansion of market share.
- Access to new geographies and customers.
- Greater revenue and profitability.
- Reduced operating costs.
- Access to new technologies and equipment.
Business acquisition financing can take many forms, including lines of credit, debt security, conventional bank loans, Small Business Administration (SBA) loans, loans from private lenders, and seller financing. Determining the right financing will depend on your business considerations, your credit standing, and the considerations and standing of the business you’ve targeted for acquisition.
Evaluating and Due Diligence
A deal can look great on the back of an envelope, but the fine print may tell a different story. The target may have substantial debt, owe back taxes, or be liable for noncompliance resolution.
To protect yourself and mitigate risk, conduct a thorough financial analysis and market research on the target business.
Financial Analysis
You need to undergo a comprehensive analysis to assess the financial health and long-term profitability of a prospective acquisition and ensure the deal adds up. Lenders may offer services for financial analysis to ensure you both feel confident in funding the acquisition. Here are factors to consider with any target business:
- Net asset value: This is the total assets minus any liabilities or financial obligations.
- Purchase price: This determines whether the cash flow can support the acquisition cost.
- Price-earnings ratio (P/E): This compares the price of a company’s stock with its earnings to determine whether it’s over or undervalued.
- Cost to build vs. buy: This is the differential of starting a similar business from scratch compared with acquiring a business.
Legal Considerations
For a seamless acquisition, it’s best to hire merger and acquisition counsel to assist you. They can meticulously evaluate all aspects of a target business, from contracts and regulatory compliance to intellectual property and employment rights. They will serve as your first line of defense to raise concerns that could impact the transaction or result in future litigation.
After due diligence indicates the deal should move forward, counsel will advise on details that impact the deal structure, such as tax implications, shareholder approvals, conflicts of interest, and even foreign regulatory issues. These aren’t items to overlook.
M&A lawyers will draft and negotiate the principal transaction agreement, outlining terms of the acquisition that can be as complex as they are contentious. Notably:
- Representations and Warranties
- Non-Competes and Non-Solicits
- Indemnification, Joint, and Several Liability
- Closing Conditions
Structuring a Win-Win Deal
As with any form of financing, it’s important to find an experienced lender that specializes in the service you need and offers flexible requirements for borrowers of your credit standing. At baseline, most lenders will require:
- Valuation and financial statements for the business you wish to acquire.
- A letter of intent with the preliminary terms of sale outlined.
- A business plan for the continued operation of the business.
- Sales projections following the transition of ownership.
- Proof of collateral and a down payment.
It’s common for business acquisition loans to be secured with assets as collateral, although they can also be financed through a cash-flow leveraged buyout (LBO). In the case of an LBO, the acquisition is structured with 90 percent debt and 10 percent equity, borrowing against the value of the target company’s assets.
Lenders that specialize in acquisition financing can offer both capital and valuable guidance. They often work closely with M&A lawyers to structure the deal with the interests of both parties in mind.
Tailoring Repayment Terms for Success
If you haven’t established a relationship with a lender yet, review your options to compare services, eligibility, and terms. Everything is a negotiation if you can make a well-reasoned case.
- Interest Rates: These will vary depending on the lender and your credit standing. If your credit isn’t ideal, collateral can improve the credit valuation of your loan for more favorable terms.
- Loan Amount: The loan amount will primarily be informed by your business plan for how to use the funds, in addition to the purchase price and your debt service coverage ratio (DSCR). Especially in leveraged buyouts—where the debt-to-equity ratio is heavily skewed—ensure your business plan positions you to manage the debt.
- Repayment Schedule: The length of your loan term will vary depending on the lender you work with and the scale of capital being financed. Longer or shorter terms may be available but are likely to shift the interest rate.
- Amortization: This is a calculated forecast of your principal and interest to be paid over time.
- Balloon Payment: At the end of the loan term, if the amortization schedule has not resolved the balance, a balloon payment requires a lump sum payment. This can help make payments more affordable over time but can also add financial strain.
Finance Your Acquisition with Diamond Business Loans
Acquiring another business can be a vehicle for strategic growth, but it isn’t without challenges. Contact Diamond Business Loans to learn more about your options and receive a free evaluation of your acquisition financing.
