Many transactions may require creative financing, and there are several creative financing options available to the willing seller.
Seller Financing. Buyers and lenders often look to the seller for financing as they try to put together a transaction. It’s a way of giving the buyer time to establish a successful track record with the business. In this scenario, the seller will take a note at an agreed upon interest rate and term – generally ranging from five to ten years. The terms of the sale may include one or more balloon payments due periodically after the purchase date. Seller financing may give banks more comfort with the transaction, as lenders know they have a seller who retains an interest in the success.
SBA Loans. In sales of a business, conventional loans usually aren’t available, so a buyer may want to consider a number of loan options available from a Small Business Administration (SBA) lender. The SBA guarantees a portion of the loan, and the buyer pays an SBA loan fee that opens the door for a loan that the bank couldn’t do conventionally. If an SBA-guaranteed loan goes into default, the SBA will pay the lending institution up to 75% of any deficit left after liquidating the collateral.
Earnouts. “Earnout” financing involves a certain dollar amount that the buyer pays to the seller based on the performance of the business after the transaction is completed. Earnouts can be structured in a number of ways and can be based on a variety of financial benchmarks, such as a revenues, gross profits or net income. Earnout financing is often used for companies that are in a turnaround situation or when the buyer places a greater emphasis on future earning potential than on past cash flow.
Mezzanine Financing. In the M&A world, mezzanine financing is another alternative for a buyer looking for capital where the financing package may include interest rates of 20% or more. The lenders in this situation are typically high net worth individuals who are expecting a larger return on their investment. They are lending in a junior lien or a position behind the bank and seller financing. The loans are typically made with limited sources of collateral, thus the request for higher interest rates. Again, this financing is often used in funding goodwill or reputation in an acquisition.
Funding Scenario. In a million-dollar transaction, the buyer would be expected to have a 20% down payment. The seller may hold an additional 10% to 20% in seller financing, and the lending institution would offer a combination of conventional or SBA financing to cover the difference, depending on collateral available. A buyer and the lending institution must evaluate a company’s cash flow and determine if it is adequate to cover their debt service and provide a reasonable return on their investment. Lending institutions will also be examining whether a buyer’s coverage ratio, or excess cash flow after all debt is paid, is adequate to cover their needs. Even if you’ve been affected by a downtown in the economy in some parts of the country, don’t let that stop you from considering your acquisition options.
Creative financing tactics are becoming more common. Talk with a business intermediary representing the company you are considering purchasing. They’ll know if the owner is willing to consider seller financing, earnouts or other creative financing ideas. Based on your available capital, the business broker should be able to tell you whether you’ll be considered for the purchase and may also provide you references to various lenders that are familiar with financing the purchase of a business.
