Question:

I am interested in pursuing the acquisition of a landscape services business.  I really think this is a good time to seriously consider acquisitions, but I all I hear is how tight the credit markets continue to be for small businesses.  How can you finance a business acquisition?

Answer:

It is undeniable that the credit markets have tightened dramatically over the past four years.  Traditionally, business buyers have financed acquisitions with a combination of available cash, SBA loans  other bank loans and seller financing.  In fact during the housing boom, one of the most common methods of financing a business acquisition was home equity loans.  Obviously, this source has largely dried up between the drop in housing values and tightened lending standards.  It is well-documented and publicized that other bank financing has become pretty hard for most small businesses to obtain.

However, that does not mean that it is impossible to finance a business acquisition.  For example, many business acquisitions are financed through SBA 7(a) loan program.  This program, administered by lending institutions, mostly commercial banks, involves loans that are 75% guaranteed by the Small Business Administration.  The banks make the loans based on government underwriting standards.

The SBA lending guidelines require a borrower to have the ability to repay the loan on time from the projected operating cash flow of the business, to be of good character, have the management expertise and commitment necessary for success and a feasible business plan.  A borrower also cannot have access to other resources to make the investment. A borrower needs reasonable (but not necessarily stellar) credit.  The loan needs to be to a small business as defined under SBA guidelines.  For most service businesses, that will be a maximum of $7 million in average annual receipts.

The maximum loan under the 7(a) program is $5 million, of which 75% or $3,750,000 would be government guaranteed.  The maximum term for 7(a) loans ranges from 10 years for loans for inventory and working capital to up to 25 years for real estate.  The term would never be longer than the remaining useful life of a fixed asset being acquired with the proceeds.  For a loan that involves working capital, equipment and real estate, the lender will determine a blended term.  The maximum interest rate on an SBA 7(a) loan is prime plus 2.75 for loans with a term of seven or more years, prime plus 2.25  for loans with a term of less than seven years.  There is also an SBA guaranty fee of 3.75% of the loan (for loans over $1 million, lower for small loans), which is usually financed as part of the loan.

Although most business buyers do not plan to acquire real estate when they acquire a business, it sometimes becomes compelling by allowing the longer blended term for the financing and thus lowering monthly payments.

This is just a general overview of the SBA 7(a) program.  For complete information on the SBA 7(a) program, visit their website at www.sba.gov.

Another area that is not well understood is the role of seller financing in business acquisitions.  We will save that for a future post.

Image courtesy of vichie81/freedigitalphotos.net

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