Acquisition Financing

Worked Example: Funding a $2 Million Purchase

Here is a hypothetical deal with round numbers. It is an illustration, not a quote.

• Purchase price: $2,000,000

• Closing costs and working capital: $250,000

• Total project cost: $2,250,000

• Funded by: $225,000 of buyer cash (10 percent), a $225,000 seller note (10 percent) and a $1,800,000 senior term loan (80 percent)

Suppose the business has averaged $435,000 a year in EBITDA (earnings before interest, taxes, depreciation and amortization), and yearly payments on the senior loan and seller note would total $290,000. Coverage is $435,000 divided by $290,000, or 1.5 times. That clears a 1.25 minimum with room for a slow year.

This structure can also work for an SBA loan, because the buyer's cash covers the full 10 percent injection and the seller note simply counts as more debt in the coverage test. If the seller put the note on full standby, meaning no principal or interest payments for the life of the SBA loan, it could supply up to half of the required injection, and the buyer's minimum cash would drop to $112,500.

From Letter of Intent to Closing

1. Letter of intent. Buyer and seller agree on price, structure, seller financing and an exclusivity period.

2. Lender conversations. Share the seller's financials, your personal financial statement and your resume with a few lenders and compare term sheets.

3. Due diligence. Review financial statements, tax returns, customer concentration, contracts, the lease and staff.

4. Third-party reports. The lender orders a business valuation, plus an appraisal and environmental review if real estate is included.

5. Approval and closing. The lender issues a commitment, then the purchase agreement, loan documents, lien filings and seller note are signed and funds go to the seller.

Deals with clean books and a single owner tend to move faster than deals with real estate, several sellers or messy records. Ordering third-party reports early prevents most last-minute delays.

Related Guides

• Business Acquisition Loans

• Partner Buyout Financing

• Management Buyout Financing

• Leveraged Buyout Financing

• Owner-Occupied Commercial Real Estate Loans

Frequently Asked Questions

How much down payment do I need for acquisition financing?
For an SBA 7(a) purchase by a new owner, plan on at least 10 percent of total project cost, and seller debt can cover no more than half of that, and only if it is on full standby. Conventional bank loans and leveraged deals usually require more equity.

Can the seller stay on after the sale?
Under current SBA rules for a full purchase by a new owner, the seller cannot remain as an owner, officer or employee but may work as a consultant for up to 24 months. Conventional deals set their own transition terms.

What if the deal includes the building?
Real estate can be financed in the same loan or separately. In an SBA 7(a) change of ownership, the business portion is limited to a 10-year amortization, while the real estate portion can stretch up to 25 years. Many buyers use an SBA 504 loan for the property instead.

Explore Financing for Your Acquisition

If you are weighing a purchase, gather three years of the seller's financial statements, your personal financial statement and a draft deal structure. Then compare acquisition financing options from more than one type of lender, so you can see how terms, equity requirements and timelines differ before you sign a letter of intent.

Acquisition financing is the capital a buyer uses to purchase an existing business, buy out an owner, or acquire the equipment and real estate that come with a deal. Very few buyers pay all cash. Most transactions combine a senior loan, a note from the seller and the buyer's own equity, and each layer carries its own cost, risk and repayment terms.

This guide explains how business acquisition financing is put together, the main deal types and funding sources, what lenders check before they approve a purchase, a worked example, and the usual path from letter of intent to closing.

How an Acquisition Is Structured

Lenders describe a deal in terms of its capital stack: the layers of money that together cover the purchase price, closing costs and any working capital the business needs after the sale.

• Senior debt. The largest loan, usually from a bank, credit union or non-bank lender. It holds a first lien on business assets, gets repaid first and costs the least.

• Subordinated or mezzanine debt. A second layer behind the senior loan. It carries a higher rate, sometimes with warrants, and fills the gap when senior lenders will not stretch further.

• Seller financing. A promissory note from the seller for part of the price. Lenders like it because it keeps the seller invested in a smooth handover.

• Buyer equity. Cash from the buyer, partners or outside investors. Equity absorbs losses first, so every lender wants to see a meaningful amount of it.

Earnouts, where part of the price depends on future results, appear in some conventional deals, but current SBA rules for 7(a) changes of ownership prohibit seller earnouts.

Types of Acquisitions and Buyouts

The right funding mix depends on who is buying and what is being bought. These transaction types are covered in more depth elsewhere in this section.

• Business acquisition loans. An outside buyer, or an existing company, purchases all of a business. This is a staple deal for SBA lenders and community banks.

• Partner buyout financing. One or more owners buy out a co-owner who wants to retire or leave.

• Management buyout financing. The managers who already run the company buy it from the founder or a parent company.

• Leveraged buyout financing. A sponsor or buyer group funds the purchase with a high share of debt that the target repays from its own cash flow.

• Owner-occupied commercial real estate loans. The buyer purchases the building the business operates from, with the acquisition or as a separate step.

When an established company buys a competitor or supplier, lenders may give weight to the combined cash flow of both businesses, which can make the deal easier to finance than a first purchase by an individual.

Where the Money Comes From

• SBA 7(a) loans. Banks and other approved lenders make these loans with a partial guarantee from the U.S. Small Business Administration. The SBA lists a maximum 7(a) loan of $5 million, and changes of ownership are an eligible use. The guarantee lets lenders accept smaller down payments and less collateral than many conventional loans require.

• Conventional bank term loans. No government guarantee, so banks usually expect stronger collateral, more equity and direct industry experience.

• SBA 504 loans. These fund real estate or long-life equipment rather than goodwill. A third-party lender generally provides at least half of the project, a Certified Development Company provides up to 40 percent through an SBA-backed debenture, and the borrower contributes at least 10 percent.

• Asset-based lenders. They advance against receivables, inventory and equipment, which can work when the target owns substantial assets but has uneven earnings.

• Cash flow and private credit lenders. Non-bank funds lend against earnings, mostly on larger, sponsor-backed deals and at higher rates than banks charge.

Beyond interest, expect an origination or packaging fee, the SBA guarantee fee on 7(a) loans, third-party reports such as a business valuation or appraisal, and legal fees for the loan and the purchase agreement.

What Lenders Look For

• Historical cash flow. Lenders underwrite mainly on the target's past results, not the buyer's projections. For SBA 7(a) change-of-ownership loans, the analysis uses the three most recent year-end statements plus current interim results.

• Debt service coverage. This compares available cash flow to total loan payments after the deal. Current SBA rules set a minimum of 1.25 to 1 for a purchase by a new owner, and many banks look for similar coverage.

• A supported price. An independent business valuation has to support the price, and SBA rules cap total acquisition debt, including any seller note being paid, at the valuation amount.

• Buyer experience. Management or industry experience that fits the business, plus a realistic transition plan.

• Cash at risk. For an SBA 7(a) purchase by a new owner, the minimum equity injection is 10 percent of total project cost, and the lender cannot reduce it.

• Quality of earnings. The SBA now requires a quality of earnings report when the business purchase price in a new-owner or expansion acquisition is $3 million or more. Many conventional lenders ask for one on larger deals too.

• Guarantees. Under SBA rules, anyone owning 20 percent or more of the borrower must give a full personal guarantee.