Organically growing a business takes time and often requires creating new products or services. For some business owners, a faster path to growth is acquisition. Buying an existing business can expand your reach and revenue quickly, but it typically takes a hefty amount of cash.
Before you start eyeing prospects, it’s essential to have the liquidity to make a purchase. In this article, we cover several funding strategies, as well as dos and don’ts when you foresee a purchase or acquisition in your future.
4 Ways To Fund a Business Acquisition
The cost of buying a business can vary greatly depending on the industry and the target company’s revenue and assets. But according to BizBuySell, the average sales price was $325,000 in 2021.
Fortunately, you typically don’t have to have the total purchase price in cash. And in fact, 100% cash financing may not be the wisest move if it brings down your existing company’s liquidity. After all, the purchase price isn’t the only money you’ll need — you’ll also need capital to run both businesses successfully once the purchase is complete.
Some financing options include:
Many banks that offer small business checking and savings accounts also provide business acquisition loans. While the Federal Reserve expects to raise interest rates in 2022 to combat rising inflation, rates are still low, so this could be a good time to lock in a fixed-rate loan.
Small Business Administration (SBA) 7(a) loans can also be used to start or acquire a business. You can apply for an SBA loan through any SBA-approved lender. The SBA guarantees up to 85% of loans for $150,000 or less and up to 75% of loans greater than $150,000.
If you don’t mind sacrificing some ownership in the company, equity financing can help you fund a business acquisition without laying out a lot of cash or taking on debt.
There are several options for equity financing, including:
- Company equity. With this option, you offer the seller equity in the newly merged business in exchange for ownership in the target company. While this option allows you to benefit from the seller’s experience and institutional knowledge, sellers are usually only willing to roll part of their equity into the acquiring business making it a partial funding solution at best.
- Third-party equity financing. Private equity firms and angel investors may be willing to provide acquisition financing in exchange for ownership in the business and a say in some of the management decisions. Third-party equity deals are beneficial because an experienced investor can help you structure and negotiate the deal. However, they can be hard to come by. According to the Business Development Bank of Canada, only about 5% of companies that seek angel investments are successful.
Some sellers are willing to finance all or a portion of the purchase price. If you can find a seller willing to go this route, it’s typically faster than applying for a loan or finding an outside investor.
Just keep in mind that most sellers require a down payment of at least 50% of the sales price, so you may still need to lay out a substantial amount of cash or take out a loan to cover the difference.
If You Want To Acquire a Business, Start Saving Cash Yesterday
The process of acquiring a business starts long before you identify a potential target. If you wait until you have a company in mind but don’t have the money required to make a deal happen, another buyer can swoop in and buy the company you have your eye on.
To avoid that scenario, create your savings plan now so when an opportunity arises, you have the cash on hand to move forward. The following dos and don’ts can help.
Don’t Ignore Your Debt-to-Equity Ratio
Some debt can help you grow your business, but too much debt can overburden you with high-interest payments and a high debt-to-equity ratio.
Your debt-to-equity ratio measures the amount of debt your business uses to fund its operations for every dollar of equity you have. You can calculate your debt-to-equity ratio by dividing your total liabilities by total shareholder’s equity.
While a “good” debt-to-equity ratio varies by industry, most lenders consider a ratio of around 2 to 2.5 to be satisfactory. On the other hand, a ratio of 5, 6, or 7 could make it harder for you to get financing.
If yours is on the higher end, avoid taking on new debt and work on paying down existing loans and credit card balances to ensure your debt-to-equity ratio doesn’t prevent you from qualifying for a business acquisition loan.
Do Maintain a Business Budget
Budgeting is an essential part of any business, so if you don’t have a budget yet, now is the time to start one.
Many small business accounting solutions include budgeting tools. If yours doesn’t, you can create a spreadsheet or use a template like this business expense budget from Microsoft Office.
Don’t Neglect Your Accounts Receivables
Accounts receivable are the amounts your customers owe you for products and services you’ve already delivered. With all of the responsibilities on an entrepreneur’s plate, it’s easy to let sending invoices and chasing down late payments fall through the cracks. But collecting receivables impacts your cash flow, and without a steady cash flow, businesses are often forced to borrow more money to meet their working capital needs.
Treat outstanding invoices like the assets they are and set up an accounts receivable process that maximizes your chances of getting paid on time.
Do Know the Difference Between Needs and Wants
Saving up 50% or more of the cost of buying a business may require reevaluating your spending habits. For example, do you really need to upgrade your car, equipment, and office furniture every two years? Are you wasting money on software and other subscriptions you don’t use? Do you spend money on business travel when a video conference could achieve the same ends?
Review your expenses regularly to look for unnecessary spending and cost-cutting opportunities, and you’ll have more money available when the right acquisition opportunity comes along.