Funding to buy a business

What it is

Acquisition finance is the money behind buying a business. That could be a share purchase, where you buy the company, or an asset purchase, where you buy the trade and assets. It also covers buying out a co-owner so you can take full control. In almost every case the funding is a blend rather than a single loan.

The thing nobody tells first-time buyers is how much the target itself does the lifting. Its profits, its debtors and its assets are all part of how the deal gets funded. Your job, with your accountant and the lender, is to build a structure the lender is comfortable with and that still leaves the business healthy after completion.

How a deal is structured

What lenders look for

Lenders weigh up four things, with the target's profits doing most of the talking:

• ✓The quality and consistency of the target’s profits, since that repays the debt
• ✓The assets that can be secured (debtors, stock, plant, property)
• ✓Your own contribution, or skin in the game
• ✓Your experience and the team running it after completion

Senior debt is sized as a multiple of the target's sustainable earnings (EBITDA), and each lender publishes its own ceiling, with the rest made up from your contribution and seller support.

Have the target's accounts ready (two to three years plus recent management figures), the heads of terms or asking price, and a clear first-year plan. Personal guarantees are normal.

How the borrowing is assembled

Acquisition debt is assembled rather than bought off a shelf, and the pieces come from different lenders. Secured lenders, unsecured lenders and, where the target owns its premises, commercial mortgage lenders each set their own limits and criteria, and we have access to all three through our lender panel.

On the property leg, a commercial mortgage is priced as an annual rate and sized against the value of the building, so the premises can carry part of the price over a longer term than the trading debt.

Two things follow. Unsecured lenders and cash-flow lenders publish different criteria and different timetables. A deal needing £2m of cash-flow lending meets fewer published criteria, no published pricing to compare, and a timetable measured in months rather than weeks. Knowing which of those you are running changes what you promise the seller about completion.

Who uses it

Typically used by:

• ✓An established business buying a competitor or complementary firm
• ✓A management team buying the business they run
• ✓An owner buying out a co-director

Lenders look for a buyer with a track record in the sector and a stake to put in. The target does the rest of the work: two or three years of provable profit is what the lender is really buying, and a business with lumpy or unaudited numbers will be sized on the worst year, not the best.

How it works

What a lender asks for

An acquisition lender underwrites the business being bought, the buyer and the structure of the deal, in that order, and asks for the evidence of each.

• ✓The target’s last three years of filed accounts and current management figures, because the debt is sized on the cash flow the target has shown rather than on the buyer’s plans for it.
• ✓The heads of terms or the sale and purchase agreement: the price, what is being bought (shares or trade and assets), the completion date and any deferred consideration or earn-out.
• ✓The buyer’s own accounts and the equity being put in, with its source evidenced, and the directors’ experience of the sector.
• ✓The structure: senior debt, any vendor loan note, any asset or invoice finance against the target’s own assets, and the equity, set out as a funding table.
• ✓A forecast for the enlarged business showing the debt serviced after the owners’ drawings, with the assumptions written down.

Which stages are in your hands

A deal completes when the buyer’s due diligence, the lawyers’ documents and the lender’s conditions all land on the same day. Most of that timetable sits with the buyer and the seller.

What can go wrong

Acquisitions fail for reasons that are visible early if the structure is tested against lenders’ published criteria before the price is agreed.

• A price agreed before the funding was tested. The buyer commits to a figure, the lenders size the debt on the target’s cash flow, and the gap between the two is the buyer’s to fill or the deal’s to lose.
• Too much debt for the cash flow. One poor quarter after completion breaches a covenant. A structure that leaves no headroom is a structure that depends on nothing going wrong.
• The seller leaving on completion. A business whose customers, suppliers or staff were loyal to the seller changes on the day the seller goes. A handover period and a deferred element keep the seller interested.
• Security that cannot be granted on the day. The lender’s charge over the target can be registered only once the target is owned, and the charge must be delivered to Companies House within 21 days of completion. A completion that depends on a charge being in place first does not work.
• Working capital forgotten. The deal funds the price. The enlarged business still needs working capital from the first week, and a buyer who spent every pound on completion starts with none.

Common questions

Sources

• NACFB, commercial finance standards
• FCA, when business lending is regulated
• Companies House, checking a target company