“Deep-pocketed investors often set aside money to buy into private equity funds. Such investments tend to be riskier but can generate higher returns than stocks or bonds. Here are some of the key players and terms in the world of private equity investments.
• Private equity firms: A broad category. It includes venture capitalists and buyout specialists who raise money from limited partners and use it to help companies develop products and markets.
• Limited partners: Investors in venture capital or buyout funds. These are typically pension funds, foundations, university endowments, insurance companies, or wealthy individuals.
• Venture capital firms: Firms that use their investment funds to finance start-ups, often in their early stages and typically in the technology, life sciences, or telecommunications fields.
• Buyout firms: They usually raise larger funds and invest them in more mature, later-stage companies of all kinds, often taking controlling interests and sometimes buying the companies outright. (The terms “private equity” and “buyouts” are often used interchangeably.)”
Source: Robert Weisman, in an article from The Boston Globe
There still aren’t too many ways to finance the purchase of a business. Here are the primary methods:
Some buyers may have the cash available to purchase the business. Some may elect to use the equity in their residence, or other real estate. Others may have other assets that they can sell or borrow against.
Banks may lend against a buyer’s assets as described above. They may also lend against the assets of the business, assuming there is sufficient value to support the loan. The business will also have to make sense to the bank, regardless of the asset value. In fairness to the banking system, many of the figures supplied by business owners have very little relationship to the actual earning power of the business.
Venture Capital Firms
These firms do not, as a practice, lend to small or even many mid-size businesses unless tremendous growth is anticipated. They also usually expect an equity position in the company.
These have become more popular. There is now some competition among lenders for these loans. Many banks offer them, but the large non-bank companies seem to have the upper hand in both acceptance and service.
This category includes family, friends, relatives, credit cards and leasing companies. Some suppliers have been known to assist in the financing of a small business.
This is, by far, the largest source of financing available for the purchase of a business. Many industry experts say that about 90 percent of small businesses sell with, or perhaps because of, the seller financing a good portion of the sale price. Buyers have much more confidence in the decision to purchase a business when the seller is willing to assist in the financing. The buyer has confidence that the seller believes the business will service the debt, in addition to providing a living wage.Read More
Business owners who want to sell their business are often told by business brokers and intermediaries that they will have to consider financing the sale themselves. Many owners would like to receive all cash, but many also understand that there is very little outside financing available from banks or other sources. The only source left is the seller of the business.
Buyers usually feel that businesses should be able to pay for themselves. They are wary of sellers who demand all cash. Is the seller really saying that the business can’t support any debt or is he or she saying, “the business isn’t any good and I want my cash out of it now, just in case?” They are also wary of the seller who wants the carry-back note fully collateralized by the buyer. First, the buyer has probably used most of his or her assets to assemble the down payment and additional funds necessary to go into business. Most buyers are reluctant to use what little assets they may have left to secure the seller’s note. The buyer will ask, “what is the seller not telling me and/or why wouldn’t the business provide sufficient collateral?”
Here are some reasons why a seller might want to consider seller financing the sale of his or her business:
- There is a greater chance that the business will sell with seller financing. In fact, in many cases, the business won’t sell for cash, unless the owner is willing to lower the price substantially.
- The seller will usually receive a much higher price for the business by financing a portion of the sale price.
- Most sellers are unaware of how much the interest on the sale increases their actual selling price. For example, a seller carry-back note at 8 percent carried over nine years will actually double the amount carried. $100,000 at 8 percent over a nine year period results in the seller receiving $200,000.
- With interest rates currently the lowest in years, sellers usually get a higher rate from a buyer than they would get from any financial institution.
- Sellers may also discover that, in many cases, the tax consequences of financing the sale themselves may be more advantageous than those for an all-cash sale.
- Financing the sale tells the buyer that the seller has enough confidence that the business will, or can, pay for itself.
Certainly, the biggest concern the seller has is whether or not the new owner will be successful enough to pay off the loan the seller has agreed to provide as a condition of the sale. Here are some obvious, but important, factors that may indicate the stability of the buyer:
- How long has the buyer lived in the same house or been a home owner?
- What is the buyer’s work history?
- How do the buyer’s personal references check out?
- Does the buyer have a satisfactory banking relationship?
Advantages of Seller Financing for the Buyer
- Lower interest
- Longer term
- No fees
- Seller stays involved
- Less paperwork
- Easier to negotiate
Where can buyers turn for help with what is likely to be the largest single investment of their lives? For most small to mid-sized business acquisitions, here are the best ways to go:
Typically, anywhere from 20 to 50 percent of cash needed to buy a business comes from the buyer and his or her family. Buyers who invest their own capital (usually an amount between $50,000 and $150,000) are positively influencing other investors or lenders to participate in financing.
This is one of the simplest and best ways to finance the acquisition, with sellers financing 50 to 60 percent–or more–of the selling price, with an interest rate below current bank rates, and with a far longer amortization. Many sellers actively prefer to do the financing themselves, thereby increasing the chances for a successful sale and the best possible price.
Venture capitalists are becoming increasingly interested in established, existing entities, although this type of financing is usually supplied only to larger businesses or startups with top management and a good upside potential. They will likely want majority control, will want to cash out in three to five years, and will expect to make at least 30 percent annual rate of return on their investment.
Small Business Administration
Similar to the terms of typical seller financing, SBA loans have long amortization periods. The buyer must provide strong proof of stability–and, if necessary, personal collateral, but SBA loans are becoming more popular and more “user friendly.”
Those seeking bank loans will have more success if they have a large net worth, liquid assets, or a reliable source of income. Although the terms are often attractive, the rate of rejection by banks for business acquisition loans can go higher than 80 percent.
Source of Small Business Financing (figures are approximate)
Commercial bank loans 37%
Earnings of business 27%
Credit cards 25%
Private loans 21%
Vendor credit 15%
Personal bank loans 13%
SBA-guaranteed loans 3%
Private stock 0.5%
The epidemic of corporate downsizing in the US has made owning a business a more attractive proposition than ever before. As increasing numbers of prospective buyers embark on the process of becoming independent business owners, many of them voice a common concern: how do I finance the acquisition?
Prospective buyers are aware that the credit crunch prevents the traditional lending institution from being the likely solution to their needs. Where then, can buyers turn for help with what is likely to be the largest single investment of their lives? There are a variety of financing sources, and buyers will find one that fills their particular requirements. (Small businesses – those priced under $100,000 to $150,000 – will usually depend on seller financing as the chief source.) For many businesses, here are the best routes to follow:
Buyer’s Personal Equity
In most business acquisition situations, this is the place to begin. Typically, anywhere from 20 to 50 percent of cash needed to purchase a business comes from the buyer and his or her family. Buyers should decide how much capital they are able to risk, and the actual amount will vary, of course, depending on the specific business and the terms of the sale. But, on average, a buyer should be prepared to come up with something between $50,000 to $150,000 for the purchase of a small business.
The dream of buying a business by means of a highly-leveraged transaction (one requiring minimum cash) must remain a dream and not a reality for most buyers. The exceptions are those buyers who have special talents or skills sought after by investors, those whose business will directly benefit jobs that are of local public interest, or those whose businesses are expected to make unusually large profits.
One of the major reasons personal equity financing is a good starting point is that buyers who invest their own capital start the ball rolling – they are positively influencing other possible investors or lenders to participate.
One of the simplest – and best – ways to finance the acquisition of a business is to work hand-in-hand with the seller. The seller’s willingness to participate will be influenced by his or her own requirements: tax considerations as well as cash needs.
In some instances, sellers are virtually forced to finance the sale of their own business in order to keep the deal from falling through. Many sellers, however, actively prefer to do the financing themselves. Doing so not only can increase the chances for a successful sale, but can also be helpful in obtaining the best possible price.
The terms offered by sellers are usually more flexible and more agreeable to the buyer than those offered from a third-party lender. Sellers will typically finance 50 to 60 percent – or more – of the selling price, with an interest rate below current bank rates and with a far longer amortization. The terms will usually have scheduled payments similar to conventional loans.
As with buyer-equity financing, seller financing can make the business more attractive and viable to other lenders. In fact, sometimes outside lenders will usually have scheduled payments similar to conventional loans.
Venture capitalists have become more eager players in the financing of large independent businesses. Previously known for going after the high-risk, high-profile brand-new business, they are becoming increasingly interested in established, existing entities.
This is not to say that outside equity investors are lining up outside the buyer’s door, especially if the buyer is counting on a single investor to take on this kind of risk. Professional venture capitalists will be less daunted by risk; however, they will likely want majority control and will expect to make at least 30 percent annual rate of return on their investment.
Small Business Administration
Thanks to the US Small Business Administration Loan Guarantee Program, favorable financing terms are available to business buyers. Similar to the terms of typical seller financing, SBA loans have long amortization periods (ten years), and up to 70 percent financing (more than usually available with the seller-financed sale).
SBA loans are not, however, a given. The buyer seeking the loan must prove stability of the business and must also be prepared to offer collateral – machinery, equipment, or real estate. In addition, there must be evidence of a healthy cash flow in order to insure that loan payments can be made. In cases where there is adequate cash flow but insufficient collateral, the buyer may have to offer personal collateral, such as his or her house or other property.
Over the years, the SBA has become more in tune with small business financing. It now has a program for loans under $150,000 that requires only a minimum of paperwork and information. Another optimistic financing sign: more banks and lending institutions are now being approved as SBA lenders.
Banks and other lending agencies provide “unsecured” loans commensurate with the cash available for servicing the debt. (“Unsecured” is a misleading term, because banks and other lenders of this type will aim to secure their loans if the collateral exists.) Those seeking bank loans will have more success if they have a large net worth, liquid assets, or a reliable source of income. Unsecured loans are also easier to come by if the buyer is already a favored customer or one qualifying for the SBA loan program.
When a bank participates in financing a business sale, it will typically finance 50 to 75 percent of the real estate value, 75 to 90 percent of new equipment value, or 50 percent of inventory. The only intangible assets attractive to banks are accounts receivable, which they will finance from 80 to 90 percent.
Although the terms may sound attractive, most business buyers are unwise to look toward conventional lending institutions to finance their acquisition. By some estimates, the rate of rejection by banks for business acquisition loans can go higher than 80 percent.
With any of the acquisition financing options, buyers must be open to creative solutions, and they must be willing to take some risks. Whether the route finally chosen is personal, a seller, or third-party financing, the well-informed buyer can feel confident that there is a solution to that big acquisition question. Financing, in some form, does exist out there.