Financing the Business Purchase
A buyer’s source of financing depends in part on the size of the business being purchased. The vast majority of businesses (and particularly the smaller businesses) are purchased with a significant portion of the purchase financed by the owner. The buyer, however, still must make a down payment and be sure that adequate working capital sources are available.
If the funds needed for the down payment are not readily available, the buyer must look for financing from an outside source. To grant such financing, an institutional lender is almost certain to require personal collateral for the loan as well as a wealth of financial and operating data of the business to be acquired. The most attractive types of personal collateral from the lender’s point of view are real estate, marketable securities and cash value of life insurance. In addition to personal collateral, it must also be demonstrated to the lender that the buyer is of good character, has a clear source of repayment, and has a good business plan.
Lenders for larger transactions may or may not require personal collateral from the purchaser; however, they will require a personal guarantee. Collateral for larger loans generally will consist of a first lien security interest in the tangible assets of the business such as accounts receivable, inventory, equipment and real estate. The lender will set loan conditions and restrictions regarding certain activities of the business. In the case of insurance companies and venture capitalists, the lender may insist on an equity position in the business and a role in major management decisions. Insurance companies typically only participate in transactions above $10 million. Commercial finance companies make loans on much the same basis as banks. While the interest rate such companies charge is usually higher than that charged by the bank, they are often willing to take more risk.
It is rare for a privately-held business to be acquired without leveraging the business’s assets in some manner, pledging them as collateral for a loan made either by the owner of the business or an outside lender. The owner has a strong incentive to provide financing if he feels it is necessary to get the price he wants for the business and has confidence in the buyer. An outside lender must be convinced that the loan’s risk of failure is minimal and represents a profitable transaction. Institutional lenders are generally conservative and concentrate rate primarily on repayment. To obtain outside financing it is important to be well prepared and have information that a lender needs to make decision. This data should be submitted in the form of a loan proposal and should contain the following items:
- Purpose of the loan
- Amount required
- Term desired
- Source of repayment
- Collateral available
- History and nature of the business
- Age, experience and education of management
- Key advisors
- Product
- Market area and method of distribution
- Major customers
- Suppliers
- Competition
- Facilities
- Employees and unions
- Three years of business financial statements
- Three years of business tax returns
- Current personal financial statement
- Pro forma business income statement, balance sheet and cash budget (for at least three years)
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