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What You Should Know About Acquisition Financing

Are you contemplating acquiring another business? If you already own a business and are looking to expand your business through acquisition, the right business acquisition depends on your business, the business being acquired, and the status of both businesses with respect to their cycle.

Acquisitions have become increasingly common as a way to expand your current business, gain market share, or enter into new related or adjacent business segments. In 2020, there were over 10,000 mergers and acquisitions (M&As) executed among U.S. businesses, with more than a thousand of those transactions valued at $100k or more.

While you can always use your business’s own capital to acquire another business, there are many reasons you may prefer to seek financing for it. In such a situation, acquisition financing is an option you might choose to pursue. What is acquisition financing, and how does it work?

What Is Acquisition Financing?

Acquisition financing is the process of obtaining capital from an investor or financial institution for the purpose of acquiring another business.

Acquisitions, of course, typically involve the purchase of equity. To acquire another business, your business must purchase equity, usually a majority stake, in the target business. Acquisition financing will provide your business with the necessary cash or credit to facilitate this purchase and, thus, execute the acquisition.

Acquisition Financing Options

If you haven’t already taken advantage of acquisition financing to acquire a business in the past, you might be wondering how acquisition financing works. It’s similar to other forms of business financing; the only real difference is that acquisition financing is designed specifically to facilitate the acquisition of another business. You must use either cash, credit, or a combination of both to purchase equity in the target business.

While acquisition financing is characterized by its purpose — to acquire another business — there are several forms that such financing can take.

Acquisition Term Loan

One of the most common options is an acquisition term loan. An acquisition term loan is a debt-based financing vehicle that’s used for acquisitions. You can obtain an acquisition loan from a bank or alternative lender. With this loan, you can facilitate the acquisition of another business.

These loan terms are tailored to the transaction to allow you to purchase the business while matching the debt structure and repayment terms to the specific characteristics of the combined companies post-transaction.

Loan terms will vary based upon the cash flow of the business(s), the industry, collateral available, funded debt to EBITDA, and other elements specific to your situation. The end result should be a debt structure that does not over-lever the newly combined companies.

It is typically a good idea to have an operating line of credit, guidance line, or both in place to accompany your acquisition financing.

Operating Line of Credit

An operating line of credit is another type of debt vehicle that allows you to freely draw money as needed. Acquisitions often have unexpected expenses, and with a line of credit, you’ll have an easier time covering the costs of any unexpected expenses. You can draw money from the line of credit while paying it back at any time.

Guidance Line of Credit

A guidance line of credit acts as a documented “preapproval” to finance a larger purchase. Each draw becomes its own term note with predetermined repayment terms. This can be useful specifically in assets-heavy companies or other scenarios where you may need to acquire higher dollar equipment to maintain the company or position them for growth.

Other Acquisition Financing Options

In some situations, securing financing is difficult. This is often the case when attempting to finance the purchase of a company that has low cash flow but a high proportion of receivables, for instance. In that case, there are other options.

Small Business Administration Loans

If you meet the Small Business Administration’s (SBA) standards for net worth, average net income, and overall loan size, you may be able to acquire a loan through the SBA 7(a) loan program with a down payment as low as 10%.

Debt Security

As an alternative to procuring funding through a bank or private lender, some businesses choose to sell bonds on the open market. While this approach lacks the structure of a traditional financing approach, it also allows for more freedoms than the rules a bank might enforce.

In Summary

Acquisitions are often a smart strategic move, allowing you to acquire another business’ resources, infrastructure, customer base, and talent pool. Acquisition financing is an excellent option way to leverage your current resources to expand your business without spending too much of your liquid funds in the process.

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