Costs
Part of 9 points worth checking on acquisition financing
Acquisition financing layers: what each takes besides money
Acquisition financing layers set side by side by what each takes besides repayment: security, guarantees, control, covenants and speed, plus two key decisions.
Every source of money for a purchase costs something other than money: control, speed, personal exposure, or a promise about how the business will be run. Comparing sources by price alone misses all of it. This page compares the acquisition financing layers by those other costs, then works through the two decisions where buyers most often choose badly. Rates and fees are left to the term sheets you receive, because they move with the market and the deal; what each layer demands of you changes far less.
What to take away
- Compare funding by what it takes besides repayment: security, guarantees, control, conditions and speed.
- The cheapest money usually has the most conditions attached, and the most patient money usually wants a say.
- What any of it costs you specifically, and what the documents oblige you to, is for your lawyer and accountant to answer on your facts.
The layers compared
Your own equity
- Wants security
- No
- Personal exposure
- Total, by definition
- Speed
- Immediate
- Control given up
- None
- What it costs if things go badly
- The first losses
- Best used for
- The base every other layer requires
Senior lending
- Wants security
- Yes, over whatever can be sold
- Personal exposure
- Commonly a guarantee
- Speed
- Slower; underwriting and conditions
- Control given up
- None, but covenants constrain you
- What it costs if things go badly
- Enforcement against the security
- Best used for
- The largest external portion
Government-supported channel
- Wants security
- Yes, plus program conditions
- Personal exposure
- Commonly a guarantee
- Speed
- Slowest; an extra layer of eligibility
- Control given up
- None, plus reporting
- What it costs if things go badly
- The same, plus program consequences
- Best used for
- Deals ordinary terms will not reach
Seller note
- Wants security
- Sometimes, and ranks behind the bank
- Personal exposure
- Sometimes a guarantee
- Speed
- Fastest to agree, slowest to be paid
- Control given up
- None
- What it costs if things go badly
- A negotiation with someone who knows the business
- Best used for
- Bridging the gap the bank leaves
Outside equity
- Wants security
- No; takes ownership instead
- Personal exposure
- None directly
- Speed
- Slow; negotiation and diligence of you
- Control given up
- Real: someone else has views
- What it costs if things go badly
- Dilution of the upside you keep
- Best used for
- Buying something you cannot fund with debt
Read the last row across. Each layer is doing a job the others cannot, which is why most purchases combine several rather than choosing one.
In the United States, the government-supported channel usually means the Small Business Administration. Its 7(a) Loan Guarantee Program is designed to help entrepreneurs start or expand their small businesses, and the SBA's 504 program is the other route buyers meet. In both, a bank or other lender still makes the decision and holds the security; the SBA's part adds eligibility rules and paperwork, which is why the table puts this channel last on speed.
The 7(a) rules show what that extra layer looks like. The program provides a loan guarantee to lenders, and its permitted uses include changes of ownership, complete or partial, which is what a business purchase is. To be eligible, the business must operate for profit, be located in the U.S., be small under SBA size requirements, be creditworthy, and not be able to obtain the desired credit on reasonable terms from non-government sources. You apply through a local lender and work directly with that lender, not with the SBA.
What each financing layer takes
Your equity
- Security
- No
- Personal exposure
- Total
- Speed
- Immediate
- Control given up
- None
- If things go badly
- First losses
- Best used for
- Base layer
Senior lending
- Security
- Yes, sellable assets
- Personal exposure
- Guarantee common
- Speed
- Slower underwriting
- Control given up
- Covenants constrain
- If things go badly
- Enforcement on security
- Best used for
- Largest external part
Gov-supported
- Security
- Yes, plus conditions
- Personal exposure
- Guarantee common
- Speed
- Slowest eligibility
- Control given up
- Reporting added
- If things go badly
- Same plus program
- Best used for
- Deals ordinary terms miss
Seller note
- Security
- Sometimes, behind bank
- Personal exposure
- Sometimes guarantee
- Speed
- Fast agree, slow pay
- Control given up
- None
- If things go badly
- Negotiation with insider
- Best used for
- Bridging bank gap
Debt or equity: the decision under the table
Debt is repaid and leaves. Equity stays and shares whatever the business becomes. The trade is not really cost against cost; it is certainty against control.
Debt or equity: certainty vs control
Debt is repaid and leaves; equity stays and shares
Debt: cheaper if business performs, unforgiving if not
Equity: absorbs a bad year, takes good years and a voice
Debt is cheaper if the business performs, and unforgiving if it does not; the schedule does not care about a slow quarter. Equity absorbs a bad year without a default. In exchange, it takes a share of every good year afterwards, plus a voice in decisions.
A buyer who takes outside equity to avoid a guarantee has swapped personal risk for a permanent partner. That can be the right trade or a regretted one.
The middle option exists too. Mezzanine capital sits between the two: repaid like debt, ranked behind the senior lender, priced for that risk, sometimes with a right to convert to ownership.
It is more common in larger transactions than in owner-operated ones. Know the shape exists so you recognize it when a term sheet arrives under a different name.
Fixed obligations against flexible ones
The second decision is how much of the price you commit to repay on a schedule.
A heavily scheduled structure maximises what you own if the business performs, but any month it underperforms you must cover from somewhere. A large deferred or contingent element leaves more of the outcome to be decided later, and costs you more in total if things go well.
The deal structures page sets out those components from the seller's side; from the buyer's side they are financing, whatever they are called.
The honest test is not which is cheaper but which you can survive. Work out what happens to each structure if the largest customer leaves in the first year, and choose accordingly.
What the covenants cost
Senior lending arrives with promises attached, and buyers read them last. A covenant in a loan agreement is a binding undertaking. It can require keeping a financial measure within a range, reporting at intervals, or getting consent to borrow again, sell assets, or change how the business is run.
They are the real price difference between two similar offers. A cheaper facility that forbids further borrowing, demands quarterly reports you cannot produce, and treats one missed measure as default can cost far more than the other.
Compare the undertakings, not just headline terms. Ask your lawyer what breaching each one lets the lender do.
Where the comparison meets the business
Two constraints run underneath all of it, and neither is negotiable by choosing a different lender.
What the business earns, on the basis set out in the valuation methods guide, sets what any schedule can be. What the business owns sets what can be secured.
A business whose value is relationships and know-how offers little security, so it attracts less senior lending no matter how profitable it is. Seller financing, equity, or a smaller price fills the gap. The acquisition financing page explains why that is the lender's view, not a prejudice.
For sellers reading this: the same constraints decide which buyers can afford you at all, which is one more reason the preparation year is about the record as much as the trading.
