Business Acquisition Financing: What Lenders Want

In 13 years of selling private businesses, financial leverage has been a consistent success factor for us in expanding the pool of buyers and closing deals. Fortunately for business owners, the Small Business Administration’s (SBA’s) loan guaranty program is an excellent funding source for deals up to about $5 million. Today’s interest rates are low, and lenders are lending now.
Here are ten things lenders look for when evaluating a loan request for a small business sale/acquisition:
From the Borrower (Buyer):
  1. Down Payment.  Lenders want a buyer to inject 15%-25% of the total project in cash, at minimum, depending on several factors including whether real estate is included in the sale. Common down payment sources are retained earnings, savings, retirement plan funds and gifts from family members. The buyer’s cash injection cannot be borrowed.
  2. Creditworthiness.  Lenders investigate a buyer’s credit at the outset of the approval process. A bankruptcy, foreclosure or judgment usually nullifies their chances, no matter how good other criteria look. Buyers should remove blemishes from their credit history before they apply.
  3. Track Record.  Individual buyers must have experience in the type of business and/or industry they are buying into. Lenders look for management experience, and they prefer to see prior business ownership. Buyers should tailor their resume to highlight  applicable management and industry experience.
  4. Collateral.  Buyers with real property to pledge as collateral may compensate for weaknesses in debt service coverage, business assets, experience, credit, or liquidity. Generally, if they have equity in real property, the SBA requires that it be used to secure the business acquisition loan as a secondary source of repayment.
  5. Business Plan.  Buyers have to submit a business plan for the business they are acquiring. Lenders want to see an intimate understanding of the business and industry. In most cases a plan calling for modest growth and incremental change is the safest bet for the buyer.
From the Company / Seller:
  1. Cash Flow.  Business cash flows must service the loan and provide adequate income for the owners. Lenders analyze the historical tax returns of the business—allowing reasonable adjustments for owner perquisites and non-recurring costs. The quality of financial records comes into play here. Your business plan also comes into play. Synergistic benefits, increases in working capital and capital expenditure needs are considered in the cash flow calculation.
  2. Positive Trend.  Nothing scares lenders more than negative sales and earnings trends in a business or its industry. Conversely, a pronounced positive trend is a thing of beauty to a lender. They often look back several years to see how the business performed through past economic cycles.
  3. Continuity.  Commitments by existing managers, key personnel, suppliers and customers to continue with the new owner represent reduced risk to a lender.
  4. Training.  Lenders want to see a well thought-out management transition plan. The training/transition period can be anywhere from 1-12 months, depending on circumstances. Be sure you negotiate this point up front and clearly spell it out in the purchase agreement or letter of intent.
  5. Seller Financing.  When a seller finances even 10-15% of a deal, subordinated to the bank note, it shows the lender that the seller is confident in the business under the buyer’s leadership. This deal point is commonly imposed by lenders.
For loans over $350,000 or whenever a buyer and seller have a close (non-arm’s length) relationship, the SBA requires a fair market value appraisal by an accredited business appraiser to validate the purchase price. The deal can’t exceed the appraised value.
Sellers are advised to prepare months or years in advance, to increase their odds of cashing out when they are ready to exit. Owners should be asking themselves, “does my business qualify for acquisition financing?”
•   •   •
Financing is a critical element of almost every small M&A transaction. For help finding business acquisition financing, call Exit Strategies at 707-778-2040 or Email us.
This is an update of my October 2011 blog. This also appeared as an article in the North Bay Business Journal in January 2012. Not much has changed with respect to financing small business sales!