As of the middle of August 2021, mergers and acquisition activity rose 24 percent for the last year. According to the data collected by Refinitiv, the number of deals has already reached $3.6 trillion and is expected to surpass December 2020 figures of $3.59 trillion. These figures are important because they are connected to acquisition financing, the process where a person or entity borrows money to purchase another business.
Today’s financial products offer entrepreneurs and other business owners various ways to acquire the capital needed to purchase a business. This financing usually comes from traditional means, such as financial institutions, specialized lenders, or private lenders. However, the borrower can expect to pay more for the loan with a private lender at higher rates.
Another source of financing is through a Small Business Association (SBA) loan. SBA offers loans that will cover 75 percent of the value of the acquisition between $150,000 and $ 5 million. The rates for these loans are competitive, with current rates hovering between eight to 10 percent, and the down payment might be as low as 10 percent. These loans require businesses to submit necessary information related to the size of the business. There are also limits on net worth, average income, and the overall loan size.
A debt security is another way to finance a business. This type of financing involves companies issuing bonds. Banks have regulations that must be adhered to, whereas the bond market has more flexibility. The target company can also be used to obtain asset-backed financing. The way it works is that the buyer shows that the company being acquired can be liquidated if it goes under. In essence, the buyer is borrowing on the company’s assets.
Using company equity to make a purchase is another method of acquisition financing. The buyers offer equity to the owners of the firm. This method allows for a smooth transfer of control in the process. One of the scenarios that might result is the two companies merge, creating a new entity that would own the equity. Alternatively, if both firms remain separate, then the target firm's value determines the equity share. Regardless of the scenario, the buyer benefits from the seller’s expertise and not paying out as much cash overall.
The buyer pays the target company owner a small down payment through owner financing and finances the rest or a portion through the seller. Then, the buyer makes installment payments to the owner. This method of acquisition financing works best during a seller’s market and allows the buyers to benefit from reduced costs and the seller to benefit from a stream of income.
Finally, a creative way to finance purchasing a business is through an earnout. This method involves paying a certain percentage of the target company’s value upfront and another percentage of the revenue for a certain term. For example, a company could pay the target company 20 percent of its value upfront and 30 percent of the revenues until the balance is paid off.
