Obtaining A Business Acquisition Loan Faces Significant Obstacles
To say the least, qualifying for a small business acquisition loan can be a difficult process. If the company is successful, the sale price would almost certainly include a considerable amount of goodwill, which can be difficult to fund. Even if the underlying assets being purchased are worth far more than the purchase price, lenders may be difficult to come by if the company being sold is not profitable. Company acquisition loans, also known as change of control funding, differ widely from case to case.
Financing Goodwill
The sale price minus the resale or liquidation value of business properties after any debts owed on the assets are paid off is the concept of goodwill. It reflects the profit that the company is projected to make in the future, in addition to the current value of its properties. The majority of lenders are unable to finance goodwill. This essentially raises the amount of the down payment needed to complete the transaction and/or receive some vendor funding in the form of a vendor loan.
In the selling of a small business, vendor help and vendor loans are very popular. You may want to ask the vendor whether they would consider offering support and funding if they are not already included in the terms of sale. There are some compelling reasons why you should consider asking the question.
In order to obtain the highest possible selling price, which would almost certainly include some goodwill, the seller will agree to fund part of the transaction by authorizing the buyer to pay a portion of the purchase price over a set period of time on a pre-determined payment schedule.
The vendor can also provide transition assistance for a period of time to ensure a smooth transition.
The vendor’s mix of funding and financing generates a positive vested interest, making it in the vendor’s best interests to assist the buyer in successfully transferring all facets of ownership and operations.
If the vendor fails to do so, the vendor will not receive any of the selling proceeds in the future if the company suffers or fails under new ownership.
This is typically a very attractive feature to prospective lenders because it decreases the probability of failure due to transfer. This is a direct reference to the next funding competition.
Business Transition Risk
Will the new owner be able to operate the organization as effectively as the previous one? Will the new owner’s clients want to do business with him? Is there an ability set that the previous owner possessed that would be difficult to reproduce or replace? Will the company’s main workers stay on after the sale?
A lender must be assured that the company will continue to perform at or above its current level of performance. There should normally be a buffer built into financial forecasts for possible changeover lags.
At the same time, several investors would purchase a company because they believe there is considerable growth potential that they can capitalize on. The key is to persuade the lender of your business’s capacity for growth and your ability to deliver superior performance.
Asset Sale Versus Share Sale
Many sellers want to sell their company’s stock for tax reasons.
However, unless otherwise specified in the purchase and sale agreement, any outstanding and possible future liability relevant to the going concern company will fall on the buyer.
Since assessing potential business liability is challenging, there may be a higher perceived risk when contemplating a small business acquisition loan for share purchase.
Market Risk
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 of control affect its competitive position?
A lender must be assured that the company will be profitable for at least the lifetime of the business acquisition loan.
This is important for a couple of reasons. For starters, a steady cash flow can make the repayment process go more smoothly. Second, a good going concern company is more likely to be resold.
If the owner is unable to continue running the business due to unforeseen circumstances, the creditor can rest assured that the business will still generate enough profit from resale to repay the debt.
A lender or investor can more quickly determine a localized market than a business selling to a larger geographic area. Community lenders may also have some familiarity with the business and know how well it is regarded in the community.
Personal Net Worth
Most business acquisition loans enable the lender to be able to pay cash for at least a third of the overall purchase price, with a tangible net worth at least equal to the loan’s remaining value.
Overleveraged firms are more likely to face financial problems and default on their company acquisition loan obligations, according to estimates.
The greater the amount of the necessary business acquisition loan, the greater the risk of default.
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