Financing Your Business Acquisition: Options and Strategies

Buying the RIGHT business means understanding the right methods to finance - whether you're a seasoned acquisition investor or still on the hunt for your first business you will need to understand how to fund your deal. We'll explore some of the most common funding methods and some creative ideas to purchase a business and even cover some of the “hidden” costs of acquisitions.

Many first time buyers are unprepared to find sources for down payments, and other essential aspects of closing deals such as due diligence, legal fees or retainers, closing costs, and escrow.

Using other people's money (OPM) is popular and difficult to achieve at 100% funding. I'd like to help set some realistic expectations for the kind of typical costs you'll add up during your acquisition and the associated financing methods.

Let’s get into some “super fun” funding details!

Common Financing Methods

SBA Loans: Small Business Administration (SBA) loans are one of the most popular options for financing business acquisitions due to their favorable terms and lower interest rates.

Pros: Lower down payment requirements, longer repayment terms.

Cons: Lengthy approval process, strict eligibility criteria, personal guarantee.

The rules are ever changing, but you can learn more about SBA loans here. Interest rates are prime rate + 2.5%-3%, BUT you can shop around for lenders that offer better rates on SBA loans. I've known several people to get as low as 7% in recent months.

Costs include a 10% down payment standard requirement (5% if the seller agrees to take a full standby note on the other half), closing costs, escrow, due diligence, legal. Although SBA loans are federally backed, they still take an automatic personal guarantee on any assets you have - this usually means a lien on your property. If you have a HELOC in use, you may be able to use those funds for a down payment and avoid a true PG, but ultimately end up tying your equity to the deal anyway.

Traditional Bank Loans: Banks offer conventional loans to finance business acquisitions, often requiring strong credit history and significant collateral.

Pros: Potentially large loan amounts, established relationships can help.

Cons: High collateral requirements, stricter lending criteria.

It has become harder and harder to get banks to lend on acquisitions for first time buyers; don't give up hope and expect to talk to several lenders before making any headway if you go this route. Costs will vary for each lender, you may be able to get lower interest rates than SBA backed loans.

Seller Financing: In this arrangement, the seller finances part of the purchase price, allowing the buyer to pay over time. The seller becomes the bank!

Pros: Easier approval, flexible terms, tax savings for the seller compared to a lump sum payment.

Cons: Higher interest rates, risk of default, may also require a PG to the seller.

It is rare to get a 100% seller financed deal, not impossible, but rare. Risk are more heavily placed on the seller. They may not be interested in doing a deal for lower than the current prime lending rate unless there's some additional chance of upside.

Earnouts, partial buyouts, forgivable notes, and even breaking the real estate into a lease (or lease option) could make the terms a win/win for everyone. A personal guarantee OR a claw-back where the seller is able to take back the business may help to reduce hesitation for this type of funding.

If you combine seller financing and SBA loans things start to get tricky with the seller being secondary to the lender. 20% is common, more than 50% is something to negotiate toward while working on deal terms and price. You can get 100% financing and even convince the seller that you'll pay the down payment out of the businesses cash flow, but you have got to be a top negotiator and showcase your business acumen to pull that off.

Uncommon Financing Methods

Private Equity (PE): Private equity firms or investors provide capital in exchange for equity in the business.

Pros: Large capital amounts, experienced partners.

Cons: Loss of control, high expectations for returns.

PE deals typically require 80% of the business to remain with limited partners (LPs) while 20% can remain with the general partners (GPs) and the legal risks of the investment is usually the responsibility of the GPs. There are a few different models for how to make this work - I personally like the Private Sponsor model with and equity exit criteria that allows for a long term hold ensuring LPs are paid out with a preferred return and the GPs are able to receive dividends AND retain the company after 5-7 years. **terms and conditions apply Other private credit or investment banking options can work but its often not easy to make contact with private offices without an introduction - raising funds is a separate skillset that takes significant time to master.

Crowdfunding: Raising small amounts of money from a large number of people via online platforms.

Pros: Access to a broad investor base, potential for low-interest capital.

Cons: Requires significant marketing efforts, may not raise sufficient funds, SEC regulations for large sums of money may prevent you from using this method for anything more than the down payment funds required.

Financial Considerations

After finding a primary source to fund your deal you will need to consider all the “other” costs in SMB acquisitions. These costs can vary from a few thousand to tens or hundreds of thousands very quickly. Remember 10% of a $4M deal is still $400K!

If you’re going to go after bigger deals you will need to either build up to a higher level of liquidity with multiple smaller business purchases, or source funds through one or more creative solutions.

1. Due Diligence Costs: Due diligence is a thorough investigation of the business being acquired. Costs can include fees for accountants, attorneys, and business valuation experts. You may even want to hire a “deal quarterback” for larger deals that require significant coordination and communication between the sellers, brokers, lenders, and diligence professionals to ensure you have a clear picture of risk and value of your acquisition. I have seen diligence fees of $10-$15k on smaller deals and upwards of $50k-$150K on larger deals (the upper end of fees for businesses above the $5M price). Range of costs vary - often your M&A legal support and transactional lawyer will end up being the same person or the same firm.
2. Legal Fees: Legal fees cover the drafting and review of contracts, ensuring compliance with regulations, and negotiating terms. Retainers often start at $10,000-$15,000 for these transactions. Be sure to find legal support familiar with M&A and willing to provide an estimate and scope of work.
3. Closing Costs: These are expenses incurred during the finalization of the acquisition, such as title insurance and escrow fees.
4. Escrow: Escrow services hold funds during the transaction process, ensuring all conditions of the sale are met before the money is released. Escrow is often split 50/50 between buyer and seller, but this is negotiable too. The fees can be between 4%-10%, often becoming a lower rate with larger amounts.
5. Other Potential Costs: Utilities deposits, real estate lease deposits, points, appraisals, etc. Broker fees, if a buyer’s broker is representing you, will typically split the fees with the seller’s broker - BUT if you negotiated a seller financed deal you will have to find a way to ensure everyone get’s paid.
6. Shop Around: Any of the professional services, lenders, and fees are negotiable - don’t let anyone convince you that there is a set standard that has no room for negotiation. Don’t be cheap, but make an informed decision before spending your own cash.

Quick Announcement!

Next month I’ll be releasing our “Serious Buyer’s Playbook” completely free! This guide will help you build credibility and instill confidence in sellers and reveal key steps in positioning you as a serious, qualified buyer. It includes 7 Proven Tactics to demonstrate your credibility and close deals.

Ways to Source “other” Financial Needs

When it comes to finding ways to finance your deal there are some tried and true methods, creative solutions, and simply your hard earned cash.

While I love the idea of using OPM (other people’s money) you can’t often get money for free. Wouldn’t you want a friend to borrow cash AND give you some interest back in return?

1. Personal Savings: Using personal savings is the most straightforward way to fund a down payment, but it requires significant upfront capital.
2. Retirement Accounts: Some entrepreneurs use funds from their 401(k) or IRA through a Rollover for Business Startups (ROBS) without incurring penalties. Similarly, you can take a loan against your life insurance plan IF it is a “whole life” policy AND it has accrued enough value.
3. Home Equity Loans: Leveraging home equity can provide the necessary funds for a down payment, though it puts your property at risk. SBA will lock up your equity - so, some people opt to take out their HELOC before landing a deal in order to control what happens to those funds and often use them as a source of down payment.
4. Family and Friends: Borrowing from family and friends can be a flexible option, but it’s crucial to formalize agreements to avoid conflicts. ALWAYS use a written agreement with the people you care about - handshake terms are much more likely to destroy a relationship you care about.
5. Equity Partners: Find someone with lots of money - tell them why you (and your deal) are the right to invest with. Combine that with your brains and solid deal sourcing skills and make a winning combo where everyone makes a pretty penny.

Be careful not to bet everything on your first acquisition. Business investments have inherent risk. If you cant afford to lose your home after using your HELOC to cover part of the purchase, then maybe its not the right funding method. Don't put your family's future at a level of risk where you can’t recover.

This isn’t gambling, it’s risk management.

Wrap it up already

Financing a business acquisition can be really simple - I like simple, and it often poses less hidden risks. If you don’t yet understand the different challenges between financial sources; continue to follow and educate yourself before choosing any one path.

By understanding both common and uncommon financing options, and and being aware of associated costs, you can better navigate the financial landscape of acquiring the RIGHT business. Proper planning and preparation are key to any venture, securing funds is no different.

If you’re hungry for more and would like to learn more “trade secrets” of how to buy the RIGHT business, let's get in touch with a quick, FREE session.

We'll tackle your business buying strategy together.

And as always - here's to your lasting success,

Sage Price