When you buy an existing business, you gain an established brand, customers, cash flow, equipment, and, often, employees. However, it’s not always that simple. That’s why understanding business acquisitions before you get too far can help! When you know what to look for, you can do better research into an existing business and position your small business growth from the start.
Here, you’ll learn everything about business acquisitions, including the financing options available to support your entrepreneurial goals.
What are business acquisitions?
Simply stated, a business acquisition means buying an existing business. In reality, though, it’s much more complex, so it’s important to have a good understanding before you proceed.
The process of acquiring a business can change depending on the business and ownership structure, the contract, and all of the assets and liabilities involved.
All of these considerations impact your deal, as well as how your lender structures a loan to purchase a business.
How to search for a business
Here are the several factors to consider while you’re searching for an existing business to purchase:
- The industry: Knowing an industry before purchasing a business isn’t necessary, but it can help. If you haven’t worked in the industry, spend some time exploring it to ensure that it’s where you want to invest your time and money. If you’re already in the industry, buying a competitor can be a great way to expand your reach and offerings.
- Price range: The asking price for a business is usually negotiable, but you should only explore businesses within your comfortable price range – if things don’t go as planned, you don’t want to put everything you have at risk. However, some variables can change your price range, such as whether real estate is offered. It’s a good idea to set a maximum base price for a business-only acquisition and then go from there.
For example, you may set a maximum price to acquire a small café of $75,000, but if the café also includes real estate, you can increase that amount. If the real estate also has an apartment above the café that you can live in, you may be able to go even higher. - Reason for the sale: With millions of people entering retirement years, many small businesses are coming on the market, but there are often other reasons for sales, too. While many sales are simply the result of a life change, as you explore opportunities, be sure to research whether an available business is still competitive in its industry or geographic area.
What are the important considerations for your business acquisition?
When you’ve narrowed your focus to a specific industry, geographic region, franchise opportunity, or price range, then there are specific considerations to explore:
1. Purchase price
There are many ways to value a business. Most often, it’s a combination of the value for tangible assets, plus a factor applied to the seller’s discretionary income or cash flow, representing goodwill. The asking price is typically negotiable, and eventually, you and the seller will agree on a purchase price.
The points that make up the purchase price are important to a lender to ensure that the value is accurately reflected in the purchase price and possible financing. For many lenders, there are additional specific considerations before a loan can be approved. For example, a lender could require a third-party business valuation if the purchase is between people with an existing relationship or if the purchase price is more than $250,000.
If the valuation doesn’t meet the required purchase price, you can either work with the seller to renegotiate the purchase price or offer additional cash toward the down payment to cover the resulting balance.
2. Asset or stock purchase
For an asset purchase, you’ll create your own business entity and purchase the assets from the seller, like goodwill and furniture, fixtures, and equipment (FF&E). Then, you’ll operate the business through the new entity. This method is used if your business entity is a sole proprietorship, a partnership, or a limited liability company (LLC).
A stock or equity purchase typically means that you’ll purchase existing stock to become the new owner of the business entity. The entity maintains all assets and some or all liabilities while allowing you to continue operations. This is more common for businesses with S-Corp or C-Corp business structures.
3. Contract terms
It’s important to have a sound contract with every sale detail. This helps you, the seller, and your lender. You’ll often have your attorney create the contract – it’s highly advised. It’s also a good idea to have your accountant review it. Here are common considerations for the contract:
- Cash: Typically, the seller withdraws all business cash before closing. This should be noted in the contract because, in some cases, the seller may leave a certain amount of cash so that the business can continue operating post-acquisition without an additional infusion of cash. This impacts the loan’s term and whether working capital is needed.
- Inventory: The contract must state whether inventory will be included in the purchase price or purchased separately. It should also state whether the seller will keep a certain inventory level from the time of agreement until closing and how much.
For example, if you’re purchasing a toy store, you’ll likely want to have inventory on the shelves when you take over. In the contract, you should clarify what happens if there is more or less than this amount at closing. - Accounts receivable (AR): There are several ways to decide this. A common method is for a seller to receive payment for work done while still the owner. In other cases, the buyer can keep all receivables, regardless of when work was completed. Similar to cash, the AR discussion determines the level of working capital needed in the loan.
- Accounts payable (AP) and other liabilities: Often, a purchase contract states that no liabilities will be transferred and that the acquisition will be free and clear of all liabilities. If any are to be transferred, a description should be outlined in the contract and the cash flow analysis.
- Real estate: When commercial property is a part of the deal, it can be financed in a single loan or separately, usually depending on your preferences or your lender’s requirements.
- Transition plan and training: It can be beneficial to receive some training and transition time from the existing owner before you take the lead. This helps you understand day-to-day operations, vendor and customer relationships, employee roles, and identify areas that can be improved or further developed early on. A clear transition plan also gives lenders confidence that the acquisition and early months of operations will go smoothly.
Where can you access financing for small business acquisitions?
When you’re ready to purchase a business, there are several ways to finance it. Cash is one strategy, although it’s often unrealistic that you have the full amount needed. Here are some options that offer many benefits:
- SBA loans: SBA 504 loans and SBA 7(a) and Community Advantage loans are excellent options for business acquisitions. These loans have repayment terms ranging from 7-25 years, depending on the type of loan and uses. The standard for a business acquisition is 10 years, although if commercial property is involved, the loan term can increase up to 25 years. A lease can also affect the loan term.
Depending on the circumstances, you may also want some working capital in your loan. This could include how the purchase contract is structured, the amount, if you have personal means to support business operations, and how much the lender is willing to offer. You may also need an independent business valuation completed for your application and approval process. - Seller financing: To help close a deal, a seller may offer funding for some portion of the purchase. While this can reduce the amount you need to borrow from another lender, it’s still considered debt for loan-approval purposes.
- Bank financing: While many business owners may not qualify for bank loans for business acquisitions, a bank may be willing to lend for some portion of a deal. For example, if the business acquisition includes commercial real estate, then an SBA 504 loan can be made in partnership between a bank and another SBA-approved lender, along with your down payment.
What are the key steps in business acquisitions?
Here’s a summary of the key steps in the business acquisition process. As you move forward, this guide can help you be better prepared for a successful business acquisition process:
1. Identify the business you want to purchase.
2. Perform due diligence where you and the seller share key information about goodwill, tangible assets, client or vendor lists, records, and more. Make sure the information is reviewed by an attorney specializing in small businesses or your industry. Also, have your accountant review the financial information, paying extra attention to the financials.
3. Come to an agreement on the purchase price and have it clearly stated in a letter of intent (LOI) or draft purchase contract from your attorney. The LOI or draft should include details on the price and determined assets and liabilities. Be sure it states that the purchase is contingent on getting approved for financing, including if your lender needs an independent business valuation.
The lender will then use the contract to conduct a business valuation. This will either be an internal valuation or, if necessary, a third-party valuation that the buyer will pay for upfront. During this time, you can work on gathering any remaining application documentation required by your lender.
4. The loan enters underwriting and decisioning, as long as your valuation supports the purchase, and you’ve provided your lender with a complete application. If the draft purchase agreement or LOI is complete with price, timing, and assets and liabilities, it can be used during this process. However, if changes occur to the LOI or draft, this could slow the process, so be sure that any changes are agreed to and documented quickly.
5. A final executed contract will be required once you’re approved, and your lender will work on preparing for closing. The finalized contract shouldn’t include any material changes to the draft used for decisioning. If there are material changes, modifications or application resubmission may be required before closing.
Although the process may take some time and diligence from you and your team, before you know it, you’ll be the proud owner with an opportunity to build on a legacy business in your community or industry!
Financing from Pursuit can make your business acquisition dreams a reality
As you explore businesses to purchase, research financing options, too. With loan options from $10,000 to $5.5 million, Pursuit can help you get the financing for business acquisitions, working capital, to purchase or improve commercial real estate, and more for businesses in New York, New Jersey, Pennsylvania, Connecticut, Nevada, Illinois, and Washington.
Contact us to learn more.
