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. To summarize, the goal of the business plan
is to create interest - not to have an investor write you a
check. In creating interest, the full story of your company need
not be told. Rather, the plan should include the essential
elements regarding why an investor should invest and spend more
time examining the business opportunity. Fortunately the rewards
are significant.
About the author:
PHAEDEAUX, LLC are experts in writing business plans for new and
existing business opportunities that have been successfully
funded. 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. For more information, visit
www.phaedeaux.com
