The business acquisition market has been steadily improving since the middle of 2011, with transaction volumes continuing to grow. This resurgence is being driven by a combination of factors that includes significant buyer demand, a growing number of businesses recovering from the recession and posting solid financial performance, and banks’ willingness to provide acquisition capital.
In fact, some banks are actively seeking quality business transactions to underwrite, creating a unique opportunity for both buyers and sellers. If both parties can demonstrate that they are worthy of the leverage and liquidity that a bank can bring to a deal, there are significant benefits to securing lending.
This article is the first of a two-part series and will focus on what a buyer should expect in order to secure bank financing for an acquisition. In the next article, we will discuss how sellers can best prepare their businesses so that bank financing is possible.
Criteria for Buyers Seeking Bank Loans
Steve Lasiewicz, Vice President of SBA Lending at US Bank, and local loan broker, Doug Adams of Emerson Capital, are experts at structuring finance packages with terms that will ensure a successful outcome for both buyers and sellers. They take a proactive approach to understanding our firm’s portfolio of sell-side engagements and are also key partners in helping our clients understand how best to qualify for lending.
There are five key criteria that they cite for buyers to consider when applying for a business acquisition loan: industry experience, cash equity, salary, personal guaranty, and credit history. By understanding the lender’s perspective, buyers can improve their chances of securing financing.
The first”and perhaps most important”criteria is whether or not the buyer has direct or related experience in the same industry as the company being purchased. When the buyer or other principals have relevant experience, the bank will expect that they know how to manage the business and its financial challenges. In this case, experience may be your biggest asset in securing a loan.
If you do not have industry experience, you should promote other transferable experiences that qualify you. This might include your previous work as a manager, owner, or in a related industry. You may also consider engaging others to participate in the business that have the industry experience you lack.
Lenders will also consider the buyer’s cash equity in the business they are purchasing. Investing in your own business will show your confidence in the venture and increase your chances of being approved for a loan. Buyers should be prepared and able to inject a minimum of 15% to 25% of the acquisition price in equity from their own funds”this amount cannot be borrowed.
In addition, the buyer must have at least three months of working capital on reserve. Depending on the cash flow of the business, the banks can’t inject the company with working capital unless the buyer can prove that his cash reserves are sufficient.
It is important that buyers account for their personal financial needs when purchasing a business. A buyer must factor in a salary that covers his or her living expenses as an adjustment to the cash flow of the business. The remaining cash flow must support the amount of bank debt.
Personal Guaranty and Collateral
Buyers should expect to provide a personal guaranty, which is a promise to repay the company debts in the event of default by the business and hard asset collateral. Just as investing cash equity in the business illustrates the buyer’s financial commitment, so does the guaranty and collateral.
The loan does not need to fully collateralized but the bank will need to get comfortable that the combination of personal guaranty and the collateral pledged are representative of deals in that size range and complexity.
With all types of loans, credit history plays a large role in the ability to qualify. A buyer must have a good credit score and a solid credit history to obtain financing to purchase a business. Credit history illustrates the buyer’s ability to pay debts and provides another data point to increase the bank’s confidence in the venture.
Benefits of Lending for Buyers
Access to bank lending can give buyers significant leverage in a business acquisition deal. With the bank’s financing, buyers can often purchase a larger business with more cash flows than what they would otherwise be able to afford, improving their chance at long-term success. Plus, they gain access to working capital lines to support their ongoing operations.
Low interest rates and amortizations of 10 or more years also mean lower payments. For a typical acquisition loan that is backed by the Small Business Administration (SBA), a borrower can secure a loan for up to $5 million at prime plus two points amortized over 10 years, and the amortization can be extended beyond 10 years if there is a transfer of real property with the business assets. A loan with this structure might require as little as a 25 percent equity infusion from the borrower.
Beyond the financial benefits of securing lending, a bank’s endorsement lends credibility to the business. When a bank is willing to lend, it means the business’s fundamentals are solid. This third party endorsement will be an asset as the new owner builds his or her business.
With so many benefits to securing financing, it should be a consideration for every potential business buyer. Improvements in the marketplace have created a growing number of opportunities for lending, and with the right fundamentals in your business plan, you could start your new venture on the right track.