How Acquisition Finance Works

How Acquisition Finance WorksThere are many different ways in which a company can grow and develop such as opening second sites, entering a new market or establishing a subsidiary brand. However, another common way is by merging with, or acquiring another business. Whilst business acquisition can be expensive, complicated and highly risky, it also offers an unrivalled opportunity for rapid growth and market dominance.

In this post we shall examine the intricacies of acquisition finance, acquisition loans, and other methods of funding for business acquisition. Note that acquisition financing and acquisition funding can be fairly complex stuff so strap yourself in and let’s begin.

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What Is Acquisition Finance?

Put simply, acquisition finance is the way in which a business finances the merger with, or take over of, another business. Buying another business is usually a very expensive undertaking and very few businesses have the cash available to do it. Furthermore, the usual lines of business credit such as overdrafts, credit cards and even business bank loans may not be appropriate in many cases.

Acquisition finance is a specialised and often complicated niche which we will look at in more detail as we go.

How Acquisition Financing Works

What makes acquisition financing particularly complicated is that there is often more than one single type of financing, and more than one single source of financing.

However, generally a business will move to buy out another business and will then look for ways to finance and fund the purchase. The funding may be sourced from a combination of bank loans, private loans as well as bonds and stock trades.

Different Types of Acquisition Funding

Firstly, remember that acquisition finance is often made up of a combination of different types of financing. For example a business may partially fund an acquisition by way of a bank loan and then offer stock for the remaining balance.

Let’s now examine what the different types of acquisition are.

●     Bank Loans

A business may sometimes be able to entirely fund an acquisition by way of a business bank loan. Many banks will consider offering their customers acquisition loans, although these will be subject to strict underwriting criteria and are usually only available if the business to be acquired has a healthy cash flow – something that even many successful businesses do not always have.

However, more risk averse banks may decline to fund an acquisition forcing businesses to look elsewhere.

●     Private Loans

Even if a bank is not willing to offer a business an acquisition loan, private lenders may be willing to do so. Private lenders are either individuals or groups looking to invest their wealth.

Private lenders usually have a much higher risk appetite than the banks and often specialise in acquisition financing.  However, interest rates and fees can be substantially higher than those charged by the banks.

Another variation on private lending is peer2peer business lending which is fast increasing in popularity.

●     SBA Loans

Eligible businesses may be able to use an SBA (Small Business Administration) Loan for the purposes of acquisition. Specifically, the SBA 7(a) loan program may be suitable as long as the applicant can satisfy the robust application criteria.

●     Debt Security

Another method of raising acquisition financing is for a business to sell bonds on the open market. The monies raised from the sale of the bonds are used to finance the sale, and then the bonds are eventually repaid from the future revenue that the newly expanded business will receive.

●     Stock Swaps

When a business is listed on the stock market, it can offer some of its stock in lieu of cash in order to finance an acquisition.

For the business that is being acquired, it offers them the opportunity to retain a presence and a stake in the merged business.

However, the business making the acquisition will effectively have to surrender full control of its decision making as well as shares of its future profits. Also, it will usually have to offer stock opinions well in excess of the cash value of the business they are seeking to acquire.

●     Owner Financing

Also known as ‘creative financing’ or more descriptively as ‘seller financing’, this method entails the buyer making a cash down payment and then the seller arranges financing for the remainder of the sale!

This may sound unusual but is actually a very useful solution when a business is actively looking to be acquired. It also offers the seller(s) a steady income stream over a period of years rather than a single large lump sum.

Acquisition Loans vs Other Forms of Funding For Business Acquisition

In summary, the most suitable form of funding for business acquisition depends on the nature of the 2 businesses that are coming together.

While acquisition loans can be hard to come by, they do mean that once the acquisition is complete, the purchaser has full control of the newly expanded business. Bonds also offer a similarly clean form of acquisition finance, but it is usually only well established businesses that can successfully raise acquisition funding in this way.

On the other hand, offering stock means that a business can fund an acquisition without cash, but loses both a great deal of control and of its future profits.