Business Acquisition Loans – Pros and Cons of Acquisition Loans

Finding the correct financing is crucial if you’re considering purchasing an existing business. An excellent answer might be a business acquisition loan. Business acquisition loans are loans that companies employ to purchase other businesses or strategic assets, including equipment. 

Business acquisition loans have a lot of benefits, but they might not be appropriate for everyone. In this article, we go over the basics of business acquisition loans as well as their advantages and disadvantages.

What Is a Business Acquisition Loan?

A business acquisition loan can help you pay for the purchase of a new firm and any additional expenses that arise from the acquisition. In reality, it’s a catch-all phrase encompassing numerous subsets of lending, such as term loans, asset financing, and mezzanine finance.

Features that are particularly noteworthy:

• Limits are often set at no more than 90% of the value of an acquired company.
• Frequently, there is a time limit. It has a limited shelf life and must be used before it expires.
• Typically, collateral is required to obtain financing.
• Term loans, asset loans, and mezzanine debt are just some of the many lending options out there.
• Interest can be capitalized and paid back at the maturity of the loan.

How Do Business Acquisition Loans Work?

The specifics of how a loan for a business acquisition is used can vary greatly amongst creditors. Banks and other financial institutions typically demand collateral when lending money for company purchases. The interest rate is usually quite high, although it might be lower or higher depending on your personal situation and the sort of loan you take out.

Term loans are similar to unsecured business loans in terms of their simplicity and the collateral required to secure the loan. Every month, your creditor will calculate interest, and there may be instances when you can have that interest rolled over into your loan principal.

Mezzanine loans are often structured as interest-only loans. The creditor may take ownership of any collateral if you are unable to repay the loan.

In asset finance, the creditor takes physical possession of the assets of your company in exchange for payment. You can either lease the equipment and then pay monthly payments to get it back or buy it outright.

Types of Business Acquisition Loans

It’s not possible to generalize about the types of acquisition loans available to companies. Instead, corporations can employ startup finance, government-guaranteed loans, credit lines, and term loans to purchase other businesses. There are a variety of loan options available, and each one has its uses and advantages.

SBA Loan

When it comes to financing a transaction, these loans typically offer the greatest interest rates available and require as little as 10% down from business owners with less-than-perfect credit.

In addition, if you take out a Small Business Administration loan, the federal government will guarantee a portion of the loan, reducing your personal risk in the event of default. However, this comes at a cost of a few points of interest above the loan’s original interest rate.

The uses for which an SBA loan can be employed vary, but in general, they are quite adaptable. Depending on the type of purchase, the loan period can go as high as 25 years.

Startup Loan

Startup loans are ideal for young enterprises with a limited track record of success, as opposed to traditional commercial loans which often need a minimum operational history of two years.

Given the reduced need for reviewing extensive financial documentation, the application procedure for these loans is typically streamlined, even when going through the SBA. It’s possible that fees are lower for startups since they often lack the resources to cover more expensive ones.

Lenders see startup loans as riskier than other types of business loans; as a result, the interest rates on these loans may be higher.

Term Loans

Term loans are straightforward financial arrangements where the creditor advances the borrower a predetermined sum of money that is repaid during the loan’s term in a series of fixed monthly payments.

Different financial institutions have different criteria for term loans. In order to qualify for term loans, the company’s profitability may need to meet a minimum threshold. It’s possible they’ll also want that your company has been running for a certain amount of time, perhaps from a few months to a few years.

Equipment Financing

New businesses might use equipment finance to buy necessary tools and machinery.

The equipment itself can serve as collateral for a loan, which is a key perk of equipment financing as it means you might not need to provide any additional security for the loan. If you are unable to make your loan payments and the financing firm decides to seize the equipment.

Financing for equipment is useful only when you need help paying for the purchase of brand-new or previously-owned machinery. To put it another way, this type of financing wouldn’t work if you were buying a company whose worth was primarily locked in intangible assets such as trademarks or in finished goods inventory.

Business Acquisition Loans: Pros and Cons

A business acquisition loan’s benefits and drawbacks will vary depending on the financing option chosen. Key benefits and drawbacks are listed below.

Pros

Many positive aspects exist to utilizing an acquisition loan to finance significant expenditures. These can change depending on your company’s specific situation, the type of loan you’re applying for, and the creditor’s terms and conditions.

In general, acquisition loans have several benefits:

• They reduce the sum of money you have to invest in an acquisition.
• You can make a purchase now and work out the payment details afterward.
• They are helpful in establishing a solid credit history for one’s company.
• If implemented properly, they can boost a company’s bottom line.
• Rather than relying on your current sales to assert a loan amount, creditors may look at what you expect to make after making the acquisition.

The use of acquisition loans is not always advisable. Enterprises may not be permitted to use them. However, business acquisition loans could be quite useful for the right people in the right situations.

Cons

• Due to the high level of risk associated with business acquisition loans, the interest rates that are attached to them are typically rather high.
• If you are unable to make your payments on time, the creditor may seize any collateral that was used to secure the loan.
• There are some creditors who will only provide loans for business acquisitions for a maximum of five years.
• Because creditors need to assert the worth of your assets, the arrangement process will typically take between three and six weeks. If you require to buy a firm rapidly, this could be a problem for you.

How to Qualify for Business Acquisition Loans

There may be more hoops to jump through when applying for a loan to purchase a business as opposed to other forms of business financing. Lenders will look at your current business’s performance as well as the business you’re buying to assert if the purchase makes financial sense.

Lenders will consider both your and the business’s credit history when you ask for a loan to buy another company. If you apply to some financial institutions, you may be required to provide a personal guarantee. Your current company and the one you’re buying will need to provide the following details for the bank to approve the acquisition.

• Name and location of the company
• A list of the company’s owners or partners
• Your company’s annual sales report.
• Details about one’s financial situation, such as income and expenses, bank transactions, and tax returns
• The current state of assets and debts
• Specifics about the security properties and/or assets
• Business strategy outlining how you want to grow the purchased company

Because the creditors will need to assert the worth of the assets or property, the processing of a secured loan for the acquisition of a firm could take anywhere from three to six weeks.

How Much Can I Borrow with a Business Acquisition Loan?

The eligibility prerequisites of the creditor will assert the maximum loan amount that you can receive. In general, loan amounts for these loans might run anywhere from $250,000 all the way up to $5,000,000.

Your credit rating, the amount of revenue your business yields, and the quantity of debt you already have are some of the elements that will assert how much money you are eligible to get. Every creditor will look at the aforementioned criteria to guarantee that your business can responsibly service the increased loan installments.

Final Thoughts

When it comes to acquiring a business or investing in a franchise, there are a wide variety of financing choices to consider. Many people go to traditional 7(a) SBA loans for their business finance needs, but term loans and equipment financing might be advantageous as well, depending on the nature of the firm being acquired and the intended use of the funds.

Conversely, startup loans are excellent for those who want to take the plunge into business ownership, especially with young, rapidly expanding companies.

You should carefully consider all the details of your potential choices, such as the rates and conditions of any loans you’re considering, any limits on how the money can be used, APR, and so on.

Keep in mind that it’s not enough to merely satisfy the bare bones of a loan’s specifications; you also need to ensure that the financing actually serves your purposes.