9 points worth checking on acquisition financing

A buyer cannot offer what a buyer cannot raise. Sellers read a modest offer as a negotiating position when it is often a funding ceiling.

Acquisition financing is not a detail arranged after the deal is agreed. It decides which offers are possible and why some transactions collapse weeks after everyone shook hands.

What to take away

1. The buyer's own equity

Equity sits at the bottom of the stack and absorbs the first losses. Every other provider wants to see enough of it to know the buyer is exposed.

A buyer contributing very little can walk away from a struggling business. Lenders price that, if they lend at all. How much equity a buyer must contribute is one of the deal structures that decide who carries the risk.

2. Senior lending

A bank or specialist lender advances the largest external portion. It is secured, repaid on a schedule, and first in line if things go wrong.

This layer is the cheapest and the most conditional. What it will advance is the practical constraint on most small-business acquisitions.

3. Seller financing

Deferred payment from the person selling closes gaps the senior lender will not. Its size is negotiated between buyer and seller, and it fills the space between what the senior lender will advance and the price. It is the most negotiable layer, because it comes from someone with an interest in the deal completing rather than from an institution applying a policy.

A senior lender may treat a seller note as closer to equity than to debt. That requires subordination: repayment ranking behind the bank, sometimes with a standstill period during which no payments are made.

Read the subordination terms as carefully as the note itself. Those terms decide whether you are paid on schedule or only when the bank permits.

4. Contingent consideration

An earn-out is not financing in the strict sense, but it does the same job. It lets a buyer commit to a total figure without needing all of it today, and it moves risk onto the seller.

5. Outside equity

A partner, an investor or a fund buys part of the ownership rather than lending against it. It is the most expensive capital in the stack because it takes the upside, and it brings governance: someone else now has views about how the business is run.

6. Debt service capacity

The first question a lender asks is not whether the business can be profitable in a good year. It is whether it can cover the scheduled payments out of ordinary cash generation, after the new owner has taken a living. Lenders put a name to that test: the debt service coverage ratio, cash available for debt service divided by the payments due in the same period. Each lender sets its own minimum.

Lenders test that against the business as it operates today, not against the buyer's plan. A buyer's projections may be reasonable and will still be discounted. The lender is not paid a share of the upside, so it has no reason to lend against it.

This is where the earnings basis argued over in valuation becomes a lending decision. Ask which measure of earnings the lender is using, and which of the seller's adjustments it will accept.

7. Collateral

The second question is what stands behind the loan if debt service fails. Collateral is the answer, and the shape of the business matters enormously here.

A business whose value is customer relationships, staff and reputation has very little a lender can take possession of and sell. Equipment, vehicles, property and, in some arrangements, receivables and inventory are collateral. A lender does not lend against those at face value: it applies an advance rate to each, a discount to appraised or liquidation value for property and equipment and a percentage of eligible balances for receivables and inventory, with slow-paying or disputed accounts excluded. Goodwill is not collateral in any practical sense.

Two businesses with identical earnings can face completely different lending outcomes for this reason alone.

8. Personal guarantees

Expect the question of who is personally on the hook. Read what any guarantee covers, for how long, and whether it survives a sale of the business.

A guarantee is easy to sign at closing and difficult to be released from later. Ask under what circumstances it is released, and get the answer in the loan documents rather than in conversation.

9. The risk factors that shrink a loan

The same facts that cut a purchase price cut what can be borrowed, and they compound: less funding means a lower offer on top of the price effect.

Work done in the year before a sale raises the price a buyer will offer and the amount a buyer can borrow. It also raises the number of buyers who can afford the business.

Government-backed programs

In several countries, government-backed schemes make small-business acquisition lending possible where ordinary commercial terms would not, usually by sharing the lender's risk rather than lending directly.

Terms, eligibility rules and costs change, and they differ by lender. In the United States the Small Business Administration runs the programs a buyer will hear named: 7(a) for general business loans, 504 for long-term finance of property and equipment through certified development companies, and the smaller Express option for faster, lower amounts. The agency sets eligibility and guarantees a share of the lender's risk; the lender sets the interest rate within the program's limits and applies its own credit standards. Elsewhere, start with the equivalent national development bank or business department.

Then take the current terms to a lender who actually writes that paper. Eligibility questions are answered by underwriters, not by websites. The SBA's Lender Match service connects borrowers with approved lenders who write those programs.

The sequence, for a buyer

The common failure is a buyer who agrees a deal and then goes looking for money. By the time the funding gap appears, the seller has taken the business off the market, told people, and lost weeks.

What each side should ask

A seller should ask, before granting exclusivity: what proportion of the price is the buyer's own money and where is it now; which lender is working on this specific business; what the lender has said it still needs.

What happens if the lender advances less than expected; and whether the buyer has completed an acquisition before and whether the funding held.

A buyer should ask the lender: what the loan is secured against; which earnings measure applies and which seller adjustments are accepted; what headroom is required between cash generation and the repayment schedule.

What the guarantee covers and when it is released; what conditions precede drawdown and how long each takes; what covenants apply afterwards and what reporting is required.

How a seller note must be structured for the lender to be comfortable.

A buyer who cannot answer the seller's questions is not necessarily unserious, but they are early. Treat the answers as part of qualification, alongside everything discussed in choosing who to deal with.

Common questions

How early should a buyer talk to a lender?

Before making offers. An indication based on your own position shapes the search. An approval on a specific business takes longer than anyone expects.

Can a seller ask to see a buyer's funding?

Yes, and should, before granting exclusivity. Ask which lender has seen this specific business and what remains outstanding.

Why will a lender not accept my projections?

It takes no share of the upside, so it lends against what the business does today. Your plan is your return, not the lender's security.

What if the loan comes in smaller than expected?

Go back to the structure before your own reserves: a larger seller note, a longer deferral, or a lower price. Funding the gap personally leaves the business with no cushion.