|
MEDIA - PRESS RELEASES |
 |
|
|
 |
Financing Creatively: Funding Options for Buyers with Limited Capital
by Chris Cumicek, CBI, Cornerstone Business Services
SOURCE: MARKETPLACE MAGAZINE, AUGUST 2004
As the economy rebounds, mergers and acquisition activity is picking up, especially in Northeast Wisconsin. Because the recession impacted cash flows and profitability, many successful businesses can be purchased at a lower price than they would have sold for several years ago.
However, just as seller cash flow was impacted, so was the down payment available to buyers who are now in acquisition mode. That means buyers have to come up with creative financing solutions to complete their transactions. They are turning to financing options like these:
Seller Financing
Increasingly, buyers and lenders are looking to seller financing to help complete a transaction. Typically with seller financing, the seller will hold a note at an agreed upon interest rate for a specific term or amortization—anywhere from five to 20 years.
Normally, these terms include a balloon payment to be made around three to five years after purchase. This gives the new buyer time to get up and running and to establish a successful track record. Often, when these balloon payments are due, the bank will come in and pay the seller out.
Seller financing makes the bank more comfortable with the transaction. Lenders know they have a seller who has a vested interest in the success of the business rather than one who will take their money and run. Based on our own experience and anecdotal evidence, we’ve been seeing seller financing in the range of ten to 30 percent of the overall purchase price.
SBA Loans
Beyond seller financing, the buyer will still need a more traditional loan. When conventional loans aren’t available, many buyers can look to the Small Business Association (SBA) for financing support.
SBA financing allows a bank to do somewhat riskier financing for those transactions which don’t have 100 percent collateral coverage, cash flows are tighter than the bank is comfortable with, or the seller has a smaller down payment than usual. In some cases the buyer can get in with a SBA loan with as little as ten percent down.
The bank uses the SBA to guaranty loans. The buyer pays a fee for an SBA loan, based on loan size, allowing them to get funding for a loan the bank couldn’t do conventionally. If an SBA guaranteed loan goes into default, the SBA will pay the lending institution up to 75 percent of any deficit left after liquidating the collateral.
The SBA has numerous loan options. The Low Doc program is for loans of $150,000 and less. This is a two-page application, and potential borrowers will typically receive a decision within 48 hours. The 7a loan program can cover a number of purchases including equipment, inventory, working capital, and at times goodwill. The SBA 504 program is typically for new construction and larger loan financing.
Some banks who handle SBA loans will be designated as either a CLP (Certified Lenders' Program) or a PLP (Preferred Lenders' Program). These designations are conferred based on the number of quality SBA loans a lender does per year.
CLP lenders have a status with the SBA that allows for loan approval with less underwriting from the SBA. PLP lenders, on the other hand, can make their own lending decisions as long as the loan fits specific guidelines.
Earnouts
Earnout financing is another way of funding a transaction. This is a certain dollar amount agreed on by the buyer and seller to be paid to the seller based on the performance of the company after the transaction has been completed.
Earnouts are structured numerous ways and can be based on a variety of financial benchmarks such as a company’s revenues, gross profits, or net income.
This is a financing tactic often used for companies that are in a turn around situation or when buyers are purchasing blue sky or potential rather than on historical cash flow.
Mezzanine Financing
In mergers and acquisitions, mezzanine financing is usually the last resort for a buyer looking for capital. This is high price money with interest rates in the ten to 15 percent range.
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 blue sky in an acquisition.
Funding Scenario
In a million dollar transaction, we would expect a buyer to come in with ten to 20 percent down payment. The seller may hold an additional ten to 20 percent in seller financing, and a lending institution will come in with a combination of conventional or SBA financing to cover the difference.
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 were hit by the recent recession, don’t let that stop you from considering your acquisition options. Creative financing tactics are becoming more common.
Talk with the brokerage firm of a company you are considering purchasing. They should be aware of whether or not the owner is willing to consider seller financing, earnouts, or other creative deal structuring. Based on your available capital, the broker should be able to tell you whether or not you are qualified to consider the purchase.
|
|
|
|
