Rules
Part of 9 points worth checking on acquisition financing
Acquisition financing mistakes: what to review before signing
Acquisition financing mistakes: review the rate, repayment, fees, collateral, default terms, prepayment, guarantees and covenants before signing.
Acquisition financing mistakes are expensive in a particular way: they surface after the seller has taken the business off the market. By then the buyer can no longer walk away calmly.
The ones below belong to the last stretch, from an agreed price to the day the money arrives. The work done before any lender was approached is behind you by then, and the documents look like formalities.
What to take away
- Read what you sign at the end with the same attention you gave the price at the beginning. The guarantee and the covenants outlive the negotiation.
- Ask what a guarantee covers, whether it reaches beyond this facility, what triggers a demand and what releases it.
- Name every covenantthe tests the business must pass and the things the agreement restricts.
- Leave headroom for an ordinary year plus one surprise.
- A purchase of this size warrants an intermediary, an accountant and a lawyer; the lawyer reads the facility documents, and nobody else in the room is qualified to.
Start with what stands behind the loan
Two businesses with identical profit can face completely different answers, because one has equipment and vehicles to secure a loan against and the other has relationships. Know which kind you are buying before the documents arrive.
Review the loan terms, not just the payment
Avoid these signing mistakes by checking the terms in the loan agreement and any security documents:
- Rate:Failing to confirm whether the interest rate is fixed or variable and how any changes are set.
- Repayment:Judging affordability by the scheduled payment alone, without checking the repayment term, amortization, maturity date, or any balloon payment.
- Fees and closing costs:Overlooking lender fees or other costs, their amounts, and when they are due.
- Collateral and liens:Assuming which assets secure the loan or what the liens cover instead of confirming their scope in the security documents.
- Default and cure:Not checking what counts as default, any notice or cure rights, and the lender's remedies.
- Prepayment:Assuming early repayment is unrestricted without checking for limits, premiums, or penalties and how they are calculated.
Asset-backed versus relationship-backed targets
Equipment and vehicles
- Profit
- Identical
- Security
- Available
- Loan answer
- Different
- Plan for
- Standard funding
Relationships only
- Profit
- Identical
- Security
- None
- Loan answer
- Different
- Plan for
- Larger seller note
If your target is the second kind, plan for a larger seller note or more equity from the start. The layers of acquisition financing show what each source expects in return, and that shapes what you are asked to sign.
Read the guarantee for scope, reach and release
A personal guarantee is easy to give at closing and very hard to be released from afterwards. It can survive the sale of the business it was given for. Put four questions to the lender before you sign.
| Ask | Why it matters |
|---|---|
| What does it cover? | Scope decides what you are personally on the hook for |
| Does it extend beyond this facility? | A guarantee that reaches other debts is a larger promise than it looks |
| What triggers a demand? | The trigger decides when the lender can come to you |
| What would release it? | Without a release condition it can outlive your ownership |
Get the answers in writing. Scope and release conditions often can be negotiated, and the time to try is before you have signed anything else.
Name the covenants before you sign
Covenants are the undertakings in a loan agreement, and they decide what you may do afterwards: whether you can borrow again, sell an asset, change how the business is run, or take money out.
A breach can permit the lender to act long before any payment is missed. This is the document that governs your ownership, and it deserves your lawyer's time.
| Kind | Examples | Ask |
|---|---|---|
| Financial tests | Debt service coverage ratio, debt-to-EBITDA ratio, fixed-charge coverage, minimum liquidity | How is it calculated, how often is it tested, and what happens on a miss? |
| Restrictions | Further borrowing, asset sales, changes to how the business is run, taking money out | Which are banned outright, and which can be done with the lender's agreement? |
Not every agreement uses every test, and no standard figure applies to every loan. The thresholds sit in the agreement itself, so ask which tests apply and read their definitions. The facility documents are where the buyer finds this out.
Leave headroom for a bad quarter
A schedule that the business can just cover in an ordinary year cannot cover an ordinary year plus one surprise. The first year of ownership is when surprises cluster.
A customer waits to see who the new owner is, a supplier revisits terms, working capital turns out tighter than modeled. Test the schedule against each one.
- Model the largest customer leaving, and see what the repayment schedule does.
- Model a supplier who revisits terms.
- Model working capital tighter than you planned.
- Structure the debt so that a poor quarter is survivable.
- Settle the working capital position early, because it decides how much cash you actually start with at closing.
Enough headroom means enough to survive the specific shocks your target is exposed to.
If the lender cuts the amount late
Go back to the structure rather than to your savings: a larger seller note, a longer deferral, or a lower price. Ask the seller before you fund the gap personally. The deal structures page shows how each choice moves the risk.
The order that avoids a weak renegotiation
- Test funding before agreeing price
- Grant exclusivity only after funding tested
- Put the actual target before the lender
- Run diligence and lender review in parallel
- Keep one consistent file across lenders
Once exclusivity is granted the seller has stopped talking to other buyers. A funding shortfall then becomes a renegotiation you conduct from a weak position, which is why the lender should see the actual target in parallel with diligence.
What the lender still asks for
Lenders verify as well as lend. The IRS says you can authorize a lender to request your tax transcript, through your account or through the lender with Form 4506-C, IVES Request for Transcript of Tax Return.
For an SBA 7(a) loan, the contents of the loan application vary depending on the size of the loan and the lender's processing method. Ask the lender for its own list rather than assuming one.
Comparing offers is sensible. Running parallel applications quietly is not: underwriters discover it, files arrive inconsistent, and a buyer whose story varies between institutions is a credit concern in themselves.
Who reads what
The lawyer reads the facility documents. The accountant checks the earnings adjustments behind the loan, because a lender will advance against what it can verify, not against the adjusted figure in the information package. The intermediary keeps the timetable.
The days around signing run to a list of their own, set out in the closing and integration checklist.
