Your Go-to Guide for Financing an Acquisition

Katie Fleming

Katie Fleming

Co-founder and COO of Owner Actions

A person sitting in a creative office smiles while thinking about how to raise capital

The costs of buying a business can be substantial. Fortunately, there are lots of ways to finance an acquisition. In this article, you’ll learn how many owners cover the costs of buying a business—and the operational costs that follow.

Important note: These practices suit business buyers purchasing an entity that’s already in operation. Many of these methods can be used alone or in conjunction with one another. You may wish to speak with a local lender to help you decide on the right approach for your unique situation.

 

How can I raise enough cash?

There are quite a few ways to raise the cash you need to cover your business’s initial costs. Let's dive into some of the most popular strategies:

 

Checking and savings accounts

Many owners use this pool of cash before considering any other cash sources. Why? Because it’s the easiest to access and use. If you have cash available in either of these kinds of accounts, calculate how much you’re willing to part with to attain your target business.

Need some help? Contact a banker who can guide you through these calculations.

 

Investment accounts

Do you own stocks, bonds, or mutual funds in a taxable investment account? If so, you might use them in one of these ways to cover your upfront costs:

 

Sell them.
By selling your securities, you could raise some of the cash you need for your investment. Keep in mind that sales can result in mutual fund fees, broker commissions, and the realization of capital gains. Be sure to speak with a qualified investment professional before proceeding with this option.

 

Borrow against them.
You might also consider a portfolio loan (sometimes called a pledged asset line) to raise the cash you need. Through a portfolio loan, lenders use your investment savings as collateral and allow you to borrow up to 70 percent of the value of your accounts. Because these loans are backed by collateral, they usually have low interest rates and are relatively easy to qualify for, provided you can meet the funding minimum your lender requires. You can learn more about portfolio loans here:

 

Be sure to speak with a banker to navigate the tax consequences you could face for selling your securities and the risks of borrowing against them.

 

Personal lines of credit

A line of credit provides access to a predetermined amount of cash that you can borrow and repay according to the terms your lender provides. Many banks will allow you to set up a personal line of credit to use however you see fit, which can include covering the costs of acquiring a business.

This option involves some degree of risk. Failure to repay the funds you borrow could negatively impact your personal credit score and prevent you from attaining favorable terms on any loans you need to take out in the future.

Interested in this form of funding? Contact a local bank or credit union or work with an online lender.

 

Retirement plans

Have you been contributing to a retirement savings account? You may be able to use those funds to cover a significant portion of your upfront expenses. There are several ways to access the funds in your retirement savings accounts. But, of course, it’s important to note that any use of your retirement savings introduces risk, and in some cases, tax concerns.

For more information about using your retirement plan to cover the costs of a business acquisition, check out this guide:

 

Home equity

Do you own a home or other properties? You may be able to borrow the difference between what you owe and what the property is worth. Many lenders offer home equity loans with favorable terms and minimal restrictions on how the funds can be used. The drawback is that these loans require you to put up your house as collateral. This means you could lose your home if you fail to repay a home equity loan.

Be sure to speak with a banker before considering a home equity loan to cover the costs of buying a business.

 

Cash-out mortgage refinance

Another option for property owners may be a cash-out mortgage refinance. With this option, you could pocket the difference between what you owe on a property and 80 to 95% of the property’s full appraised value.

Rates and closing costs can be higher with this option than a traditional refinance, so this option should be considered carefully before moving forward. Speak with a banker before considering this or any other lending option.

 

Second mortgage

You may also consider taking out a second mortgage on a property you own to cover some of your business costs. Second mortgages are structured very similarly to a traditional home mortgage with clear repayment terms and interest requirements.

It can be difficult to find a lender who’s willing to provide this type of financing. Most banks view second mortgages as higher-risk investments of their money. Those that offer them charge higher interest rates than they might for a traditional home mortgage. Again, you should speak with a banker before considering a second mortgage.

 

Seller financing

Some smart sellers are willing to provide buyers a loan to finance part of an acquisition. After verifying your credit and assessing your management and industry experience, the seller may agree to loan a portion of the agreed-upon sales price in exchange for regular loan payments and interest.

You can learn more about this option here:

 

Term loan

Many owners apply for term loans to cover part of their acquisition costs. Term loans, which can be attained through a bank, credit union, or online lender, generally have favorable terms and long repayment schedules. However, they can be difficult to qualify for, especially for borrowers with less-than-perfect credit.

Want to learn more about term loans and their qualifications? Check out this resource:

 

SBA loan

SBA loans are one of the most commonly used tools to cover the purchase of a business. Named after the Small Business Administration that guarantees them, these loans allow buyers to finance a large portion of their startup costs, working capital expenses, equipment needs, and building acquisition or improvements.

The SBA offers three kinds of 7(a) loans to small business owners to cover up to 90 percent of their startup costs, working capital, and equipment needs. They also offer 504 loans for the purchase of existing buildings, the purchase of land or land improvements, the construction of new facilities, the renovation of existing facilities, or the purchase of long-term machinery.

To learn more about SBA loans and their requirements, check out this guide:

 

Asset-backed financing

Many lenders offer asset-backed loans to buyers who are willing to leverage their new business’s valuable assets. Through these loans, you might finance your business’s inventory, machinery, non-mortgaged real estate, or other tangible assets to access fast funding.

Asset-backed loans are often easy to qualify for and attain, even for borrowers with less-than-perfect credit. To learn more about asset-backed financing, read this guide:

 

Assume the business's debt

If you’re buying a distressed business, you may be able to arrange a little-or-no cash-down purchase. How? By agreeing to take on the business’s debt or allowing the seller to keep the business’s receivables.

You can learn more about this option in this guide:

 

Lease the business

You could enter a lease-to-buy agreement with the seller to help you arrange for a future purchase after experiencing the business firsthand. If you enter this arrangement, you should work with an attorney to set clear terms and conditions for the future sale.

Would you like to connect with an attorney? Click the Connect button to get started:

For more information about this option, check out this guide:

 

Equipment leasing

Rather than buying and leveraging the equipment your business needs, consider leasing it. Many equipment wholesalers and distributors offer five-year leases. Some also provide the option for purchasing the equipment at the end of the lease period.

You can learn more about this option here:

 

Commercial mortgage

Do you need a storefront or commercial site? If you’re interested in buying rather than leasing property, consider a commercial mortgage. This form of loan can be used to purchase an owner-occupied office building, retail center, warehouse, or other commercial property.

Commercial mortgages differ from residential mortgages in a few key ways. The terms often range from five to twenty years, and the amortization period extends past the term of the loan. Loans structured this way usually require a borrower to make monthly installment payments for the life of the loan and a final balloon payment.

These loans may require higher down payments than SBA-backed options. They can also be slightly more difficult to attain. Further, many lenders require borrowers to guarantee the loan, especially if the borrower is an individual or an entity with no borrowing history.

Learn more about commercial mortgages in our article in this guide:

 

Commercial bridge loan

Bridge loans can be a great way to cover commercial real estate costs and other high-ticket items, including large batches of inventory, renovations, or repairs. These loans can often be attained quickly and relatively easily, even for borrowers with less-than-perfect credit. The loans are collateralized, so lenders tend to worry less about a borrower’s credit history and credit score. However, most will still require a credit check for loan approval.

To learn more about this option, check out this resource:

 

Commercial hard money loan

Some non-bank lenders offer commercial hard money loans that are secured by the borrower’s property. This short-term option allows owners to purchase a commercial property quickly, with flexible terms, and often without checks to the borrower’s credit history. Keep in mind that the interest rate on these loans is usually high. Because of this, many borrowers view these loans as a last-resort option and refinance them into a mortgage at a later date.

Some online lenders offer hard money loans, but most small business owners turn to friends, family members, or local real estate investors to secure this form of funding. Be sure to evaluate the terms of a commercial hard money loan carefully before proceeding with this option.

Learn more about this option and other commercial real estate loans in our guide, Small Business Financing 101: How Commercial Real Estate Loans Can Help You with Your #Location Goals.

 

Partnership

If you find you can’t raise enough cash through other means or you aren’t comfortable tapping into a significant portion of your savings or equity, consider bringing on a partner who can help you cover your initial costs.

Similar to the options above, there are risks and benefits to partnerships you should consider carefully. Want more information about forming a partnership? This guide can help:

 

Important note: Before selecting any financing option for your acquisition, you should speak with a banker who can help you evaluate your choices, raise the cash you need, and minimize your risk exposure.

 

Will there be closing costs?

Often, yes. Closing costs for loans tend to run between 10-20% of the purchase price of the business. Plan to have this cash on hand to take ownership of your new venture.

 

What else should I know to finance an acquisition?

If you aren’t sure whether the business’s cash flow will be strong at the outset, you should make moves in advance to secure the capital you need for operations, not just the acquisition. You could choose to fund an initial cash reserve from your personal savings, or you might borrow against a business line of credit, which you can pay down when your cash flow improves. You can also consider invoice factoring, an approach that allows you to gain access to cash by selling the financial rights to your invoices to others.

 

How should I proceed?

Work with a banker and decide which options make the most sense for you. Your banker can help you evaluate your choices and explain the documents you'll need to secure financing for your new venture.

Would you like to connect with a bank and get set up with a banker? Check out these options:

 

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Square Banking

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