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The epidemic of corporate downsizing in the U.S. has made owning a business a more attractive proposition than ever before. As increasing numbers of prospective buyers embark on the process of becoming independent business owners, many of them voice a common concern: how do I finance the acquisition? Prospective buyers are aware that any credit crunch prevents the traditional lending institution from being the likely solution to their needs. Where then, can buyers turn for help with what is likely to be the largest single investment of their lives? There are a variety of financing sources, and buyers can find one that fills their particular requirements. (Small businesses--those priced under $100,000 to $150,000--will usually depend on seller financing as the chief source.) For many businesses, the following are the best routes to follow: Buyer's Personal Equity In most business acquisition situations, this is the place to begin. Typically, anywhere from 20 to 50 percent of cash needed to purchase a business comes from the buyer and his or her family. Buyers should decide how much capital they are able to risk, and the actual amount will vary, of course, depending on the specific business and the terms of the sale. But, on average, a buyer should be prepared to come up with something between $25,000 and $150,000. The dream of buying a business by means of a highly-leveraged transaction (i.e. one requiring minimum cash) must remain a dream and not a reality for most buyers. The exceptions are those buyers who have special talents or skills sought after by investors, those whose business will directly benefit jobs that are of local public interest, or those whose businesses are expected to make unusually large profits. One of the major reasons personal equity financing is a good starting point is that buyers who invest their own capital start the ball rolling--they are positively influencing other possible investors or lenders to participate. Lenders and investors will be less impressed if the buyer declines to put his/her personal money into it. Serious buyers should use savings, cash in their IRA (expect to pay some penalties) or 401(k) to fund their new venture. More information on how to implement this option without impacting retirement savings is addressed below in this article. Seller Financing One of the simplest--and best--ways to finance the acquisition of a business is to work hand-in-hand with the seller. The seller's willingness to participate will be influenced by his or her own requirements: tax considerations as well as cash needs. In some instances, sellers are virtually forced to finance the sale of their own business in order to keep the deal from falling through. Many sellers, however, actively prefer to do the financing themselves. Doing so not only can increase the chances for a successful sale, but can also be helpful in obtaining the best possible price. The terms offered by sellers are usually more flexible and more agreeable to the buyer than those from a third-party lender. Sellers will typically finance 30 to 50 percent--or more--of the selling price, with an interest rate below current bank rates and with a far longer amortization. The terms will usually have scheduled payments similar to conventional loans; the tax picture, however, can be better than with straight debt. As with buyer-equity financing, seller financing can make the business more attractive and viable to other lenders. In fact, sometimes outside lenders will refuse to participate unless a large chunk of seller financing is already in place. Investors An angel investor, private investor, or venture capitalist may invest even before there is a real product or company organized (called angel investors seed money, seed capital or seed investing), or may provide offer venture capital to company in its first or second stages of development known as early stage investing. The angel investor or venture capitalist may invest in a company throughout the company's life cycle. Sometimes the angel investor venture capitalist may help the company with an acquisition or merge with another company by providing liquidity and himself make an exit. Venture capitalists may invest in various industry sectors, various geographic locations, or various stages of a company's growth or they may be specialists in some industry sectors, or may seek to offer venture investments for only a localized geographic area. Not all venture capitalists are willing to invest in start-ups. Unlike other venture capitalists, "angel investors" are willing to provide funding for start-up businesses without asking for a large equity stake in the growing business. So there is a slight difference. Angels differ from traditional venture capitalists in another significant way: while conventional venture capitalists typically invest relatively large sums, angels often contribute relatively modest amounts to businesses very near the beginning of the start-up cycle. Professional venture capitalists will be less daunted by risk; however, they will likely want majority control and will expect to make at least 30 percent annual rate of return on their investment. Small Business Administration Thanks to the U.S. Small Business Administration Loan Guarantee Program, favorable financing terms are available to business buyers. Similar to the terms of typical seller financing, SBA loans have long amortization periods (ten years), and up to 70 percent financing (more than usually available with the seller-financed sale). SBA loans are not, however, a given. The buyer seeking the loan must prove stability of the business and must also be prepared to offer collateral--machinery, equipment, or real estate. In addition, there must be evidence of a healthy cash flow in order to insure that loan payments can be made. In cases where there is adequate cash flow but insufficient collateral, the buyer may have to offer personal collateral, such as his or her house or other property. Over the years, the SBA has become more in tune with small business financing. It now has a Lo-Doc program for loans under $100,000 that requires only a minimum of paperwork. Another optimistic financing sign: more banks are now being approved as SBA lenders. Lending Institutions Banks and other lending agencies provide unsecured loans commensurate with the cash available for servicing the debt. ("Unsecured" is a misleading term, because banks and other lenders of this type will aim to secure their loans if the collateral exists.) Those seeking bank loans will have more success if they have a large net worth, liquid assets, or a reliable source of income. Unsecured loans are also easier to come by if the buyer is already a favored customer or one qualifying for the SBA loan program. When a bank participates in financing a business sale, it will typically finance 50 to 75 percent of the real estate value, 75 to 90 percent of new equipment value, or 50 percent of inventory. The only intangible assets attractive to banks are accounts receivable, which they will finance from 80 to 90 percent. Although the terms may sound attractive, most business buyers are unwise to look toward conventional lending institutions to finance their acquisition. By some estimates, the rate of rejection by banks for business acquisition loans can go higher than 80 percent. With any of the acquisition financing options, buyers must be open to creative solutions, and they must be willing to take some risks. Whether the route finally chosen is personal, seller, or third-party financing, the well-informed buyer can feel confident that there is a solution to that big acquisition question. Financing, in some form, does exist out there. Business Plans and Private Placement Memorandum Can Be Vehicles for Financing Gone are the days of pitching investors with hot new technology ideas. Today, entrepreneurs are much more likely to dive into their own pockets and hunker down for a battle to start up and stay alive. But if you don't have the cash in your wallet, what do you do? Luckily, there are still options for funding new companies, but finding and securing the cash will take careful research, good negotiating skills, and, above all, an unflagging commitment to launching your new business. Start your capital search with a good business plan that shows investors and lenders your company's potential. Follow that up with a thorough knowledge of the resources available and a determination to make your business a reality, and you should be on your way to uncovering a source that fits your new business's cash needs. How long should a business plan be? A business plan needs to be whatever length is required to excite the investor, prove that management truly understands the market, and detail the execution strategy. From surveys of investor needs, 15 to 25 pages of text is the optimum length in which to accomplish this. Any more and the time-constrained investor will be forced to skim certain sections of the plan, even if they are generally interested, which could lead them to miss essential elements. Any less and the investor will think that the business plan has not been fully developed, or he or she will simply not have enough information to make an investment decision. Many management teams feel that their company is too complex to describe in 15 to 25 pages. While this is sometimes true, the business plan is not meant to tell the whole story. Rather, the company must be “boiled down” into its essential elements. If the investor is interested, there will be plenty of additional time to tell the whole story. Business plans, like other marketing communications documents, should be visually appealing and easy-to-read. This can be accomplished by using charts and graphics and by formatting the plan for readability. Effectively using these techniques will enable the investor to more quickly and easily understand the company’s value proposition within fewer pages. While the body of the business plan should be 15 to 25 pages, the Appendix can be used for supplemental information. The Appendix should include a full set of financial projections, and as appropriate, technical and/or operational drawings, partnership and/or customer agreements, expanded competitor reviews, and lists of key customers among others. If the Appendix is long, a divider should be used
to separate it from the body of the plan, or a separate Appendix
document should be prepared. These techniques ensure that the investor
is not handed a thick business plan, which will make them queasy
before even opening it up. PHAEDEAUX, LLC are experts in writing business plans for new and existing business opportunities that have been successfully funded. We offer flexible options in length, levels of detail, and pricing. We do all the heavy lifting that includes market research, industry trends analysis, competitive research and analysis, marketing plans and strategies, and detailed financial projections across five years. We have access to a network of 6,000 investors.
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