There are a lot of reasons your business might look into financing a business—that is, purchase another company.
You like its location.
The company you're eyeing is extremely well run, and you feel you'll be able to adopt some of its procedures and make them your own.
You are impressed with the company's brand equity and don't plan on changing a thing, other than what bank account the revenue goes into.
Whatever your reasons, deciding to buy a business is the fun part. Financing a business is less so... Well, unless analyzing loans and studying up on financing a business is your idea of fun. If so, you're in for a lot of fun.
Either way, financing a business can be an extremely detail-heavy process. There's a lot to consider.
1. Decide what loan is right for you when financing a business.
If this is your first time acquiring a business, you may want to head over to your bank or go to the U.S. Small Business Administration website and apply for an SBA loan. As you probably know, the SBA won't actually be lending you money. You'll be getting a loan from a bank that works under the SBA's guidelines.
“There are a lot of different lending options for business, whether you're into manufacturing, or if you're a restaurant or whatever your business's identity is," says Carl Knoblock, the SBA acting regional administrator and Richmond district director.
It's hard to say what lending option is right for you since no business is the same. But Knoblock suggests looking at the SBA 504 Loan program. These are loans that offer long-term, fixed-rate financing, and they're often used to buy fixed assets—like another company's warehouse or manufacturing equipment—for expansion. The maximum amount you can borrow for these loans is $5 million.
Another popular SBA loan for companies looking to purchase an existing business is SBA 7(a) loans. The most you can borrow is, again, $5 million, and the average loan amount in fiscal year 2015 was $371,628.
“We also have a program that a lot of people aren't aware of, the Small Business Investment Company program," Knoblock says.
"These loans can go larger than some of the other loans because it's actually investors and venture capitalists who are funding the loans. They've basically partnered with the SBA," Knoblock says.
2. Prepare a business plan that presents a strong case for acquiring a new business.
You may know that buying a certain company is a smart play—but you may still have to prove that to the lender helping you with financing a business. Having a detailed business plan explaining why this acquisition is a key part of your business strategy can help.
Knoblock says that he encounters established business owners who can't answer relatively simple questions like, "Is your industry mature, or is it growing?"
“Sometimes you'll get very vague answers, which shows they haven't done the research," Knoblock says. “Or they've heard that their competitors are buying companies like these, and they simply want to stay competitive."
No matter how long you've been in business, or how well you've run your company, Knoblock says that you still have to do market research if you want to prove to a lender that an acquisition isn't a risky bet.
There are other considerations that lenders may inquire about, especially if they aren't already outlined in your business plan. The loan may be contingent on continuing to employ the business's personnel, if the lender is convinced that the business talent is an asset to the success of the company you're buying, Knoblock says.
He also suggests thinking about management styles. Knoblock has seen what can happen when a business owner buys a company that has a vastly different management style and does nothing to bridge that gap.
“One company that didn't think that process through created a lot of turmoil where they weren't working as a unit. Orders were missed, and they lost market share," he says. "In one instance, the company was sold once again. In another, a third company was brought in to help improve communication, and that did help."
Knoblock knows of another acquisition where the contract didn't cover the inventory. The business owner was more than a little stunned to find that out later.
“It wasn't part of the contract agreement. You can't make assumptions," says Knoblock.
3. Lawyer up.
Most industry experts will tell you to hire an attorney. Attorneys should be able to circumvent problems like, for example, buying the building of a company but not what's inside of it. What type of lawyer you work with may depend on the size of your company.
“Primarily for financial reasons, business owners tend to work with similarly sized law firms," says Owen Kaye, a Los Angeles tax attorney at the firm Givner & Kaye. "Thus, while smaller companies tend to work with solo corporate practitioners, only larger companies tend to engage the larger M&A firms."
So should you hire an attorney before lining up the financing for a business or after?
That depends, according to JR Lanis, a mergers and acquisitions attorney in Los Angeles with Drinker Biddle.
“If it's a typical bank financing, it could go either way," Lanis says. "The terms tend to be what they're going to be. But if it's a large enough deal, and the bank really wants your business, and you have the room to negotiate, then you might contact someone like me before the financing."
He recommends having an attorney at the beginning of the process if your business is getting the funding through private investors. In that case, he says, everything's negotiable.
It's also a good idea to have a lawyer to advise you before signing for any acquisition loan, Kaye says.
“Many business owners may not understand the critical financing components—bridge loans versus long-term financing—and the various loan conditions, such as minimum and maximum loan amount, repayment conditions and schedules, interest rates, fees and penalties," he explains.
He adds that your attorney may be able to help with other wrinkles when it comes to financing a business, such as guarantee forms and the repayment schedule.
And those are just the issues swirling around the loan. Lanis points out that you may be buying that company's tax problems, employment and labor difficulties or environmental issues.
You may find some clues to the real health of the business you want to buy if you examine the last three years of its tax filings, according to Knoblock.
“That's critical," he says. "You want to know if they've been profitable. Even if they're breaking even, you can probably do something. If they've been losing money, that can cause a ripple effect with the business you want to buy. Maybe they're simply losing money, but odds are that they're not taking care of the equipment. There can be a real ripple effect."
In other words, when it comes to financing a business, you want to buy a company that will turn out to be a bargain. You don't want to buy more than you bargained for.
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