It is often said buying an existing business costs less than building one from the ground up. If you are an entrepreneur, and this is exactly what fuels your entrepreneurial vision, then knowing about the different options that you can leverage to raise capital for your acquisition venture is sure to help you.
Below, we have compiled a list of five ways to finance a business acquisition, reviewing the pros and cons of each approach, so that you can make a decision that is best for you.
This is the most common way to finance a business acquisition—and based on the familiarity with the lending source, probably the most reliable. Hence why, many prefer to approach a bank when they initially start their search for a solution.
It’s understandable. You know who you are dealing with.
However, it’s not the most convenient option out there. Acquiring a business loan from a bank requires you to comply with many rules and regulations. You need to have a good credit score. In most cases, your experience also counts—not to mention your profile as an investor.
If you are an experienced entrepreneur, then these eligibility requirements shouldn’t be a problem. But if you are a first-time investor, it could be challenging for you to get approved for a bank loan.
Asset based financing is provided by large investment firms and private lenders. It is basically loan financing, where you secure the loan against the value proposition of the assets of the business that is to be acquired. This includes stock, debtors, equipment inventory etc.
That being said, it’s important to note that not every type of asset can be used as a collateral. Lenders usually focus on assets that have low depreciation rate, high value and can be easily converted into liquid cash. This poses limitations when applying for asset based financing.
Equity based financing, like asset based financing, is offered by private money or hard money lenders. It is a loan that is secured against a property in which you have some equity. Most lenders require the borrower to have at least 25% equity in the asset that they are willing to submit as a collateral.
To be eligible for equity based financing, besides equity, you need a business plan that is viable, functional and profitable. In other words, lenders look how good your business idea is when evaluating your application for the loan request.
The disadvantage of equity based financing is it carries higher interest rate than all the other types of loan previously discussed. This is because of the minimum due diligence involved in the process.
Seller based financing is a type of financial arrangement agreed with the seller of the business, who then fund the acquisition in partial or in full. It is a loan that you have to repay to the seller as per the agreed terms.
This could be a very convenient option for first time entrepreneurs but it carries few disadvantages. Firstly, it’s hard to find a seller willing to provide seller based financing. And secondly, the business owner is likely to price the business at a high value in return of the favor.
Where almost all loan options require you to contribute a certain percentage of the investment capital, investor based financing does not. If you don’t have any money to invest, neither do you have an equity in a property – this could be the option most convenient for you.
However, it comes with a catch. The investor would ask for equity in your business and depending on the amount of money that the investor is willing to contribute, the equity share will accordingly vary. This could limit you from exercising complete control of the business.
So, which option did you find best suited to meet your unique needs and financial goals?