Partner acquisition financing is the process of obtaining funds to purchase equity in a business partner. This financial vehicle is typically used when a partner wishes to exit the business for strategic, personal or financial reasons, and the remaining partners wish to buy out their shares to gain full control or to reallocate their shares among existing members.
Financing can come in many forms, including bank loans, private loans or seller financing. A successful partner acquisition requires careful negotiation, a clear valuation of the business, and a thorough understanding of the legal implications to ensure a smooth transition and maintain business operations. This article will discuss some common acquisition financing routes and focus on some of the advantages and challenges of each approach.
How do you fund an acquisition as a remaining partner?
As a remaining partner, partner acquisitions can be funded through a variety of financial strategies. Here are some options to consider:
- Equity financing: This involves raising capital by selling shares in the business to private investors or venture capital firms. By bringing in new investors, you can obtain the necessary funds to purchase a partner’s shares. However, this will result in sharing in future profits and often losing some control over the business.
- Debt financing: This is a common option where you can obtain a loan from a bank, credit union, or private lender to facilitate the acquisition. While this option avoids ownership dilution, it does increase debt obligations requiring regular repayments and interest costs.
- Mezzanine financing: Mezzanine financing is a combination of debt financing and equity financing. If the borrower (in an acquisition, typically the remaining partners in the business) defaults on the loan, the mezzanine lender has the option of converting its debt into equity in the company.
- Small Business Administration Loans: Using an SBA loan to facilitate a partner acquisition is a special form of debt financing. While not all SBA loans are available for acquisition programs, SBA 7(a) loans are available for partnership acquisitions. This government program typically offers longer loan terms and more relaxed underwriting guidelines than traditional bank loans.
- Refinancing assets: Another unique variation on debt financing is refinancing a company’s current assets. For example, a company may have an interest in its real estate, equipment, or inventory. Through refinancing, partners can convert this equity into cash, which can then be used to acquire partners’ shares.
Choosing the most appropriate financing method depends on factors such as the financial health of the business, the urgency of the acquisition, and your long-term business goals. Each option has its own advantages and trade-offs, so careful consideration and possibly consultation with a financial advisor is recommended to determine which option is best for your particular situation.
How to choose the right financing option for your acquisition
When narrowing down the right financing options for your partner acquisition scenario, start by evaluating your company’s financial situation and goals, paying particular attention to long-term strategic goals post-acquisition. Consider the capital cost required for each option, the repayment terms and the degree of control over the business operations. Let’s look at each financing type in more detail.
Equity financing
Equity financing is a permanent relationship with a new group of co-owners. The business received an infusion of new capital but gave up permanent ownership of the shares in the business. The benefit is that your business receives an infusion of capital that can have a positive impact on performance and growth.
These new co-owners can become silent partners, allowing you to run your business as long as their business’s annual returns meet their targets. Others may be operating partners who play an active role in business operations.
Some equity investors will be interested in quickly increasing the value of the business so that they can sell their shares to other investors for a profit. When equity partners have misaligned growth and exit goals, it can destabilize the business, servicing some partners but not others.
Additionally, the company will now pay out a percentage of proceeds to new investors. It can be paid out as dividends, but investors may also want to enter into a relationship that reinvests their percentage into the business, growing their equity until they want to cash out. The sudden exit of an equity partner can harm the business as much as an equity infusion at the beginning of the relationship helps, requiring the remaining partners to find a new equity partner or choose other options to refinance the exit.
For many equity investors, the ultimate goal is to grow your business to the point where it is acquired by a larger company. Many companies that received equity, especially from venture capital funds, found themselves in a hole from which they could not escape. Our goal is to find more and more equity and grow the business until it is acquired or goes public. When it’s a common goal, it can be a great game. But if the remaining partners are just small and medium-sized businesses that want a minority stake, they have to think carefully about who they build an equity relationship with.
debt financing
Securing debt financing can be a daunting task for businesses due to strict lending standards imposed by banks and other traditional lenders. These institutions often require a good credit history, substantial collateral, and detailed financial documentation, making it difficult for many businesses to qualify. These standards can be particularly daunting for startups and small businesses that don’t yet have a long-term record of financial stability.
Private lenders, on the other hand, while more nimble than banks, face their own set of challenges. They are often niche-oriented, each focusing on a specific industry or sector, which can make the process of finding the right lender difficult. It’s not uncommon for businesses to spend a lot of time and resources searching for the right lender, like looking for a needle in a haystack. This complex and time-consuming process can delay necessary capital investments and create significant obstacles to timely capitalizing on growth opportunities.
The main risk of debt financing is obtaining more funds than the business can repay. If the market changes and your business revenue drops significantly, your business could fall into default. Therefore, it is crucial to manage a company’s debt service coverage ratio and invest capital in profitable activities.
Remaining partners should also realistically consider the revenue generated by existing partners when forecasting acquisition options. This allows the continuation plan to actually address potential changes in revenue post-acquisition. To remain stable, a business must be able to make a profit even after the loss of revenue caused by the departure of a partner and the increased costs caused by new debt.
This coin also has its flip side. The biggest benefit of debt financing is that the remaining partners or sole proprietors can grow the business and retain ownership without the influence of the other partners. This means having more control over the business and the ability to retain a higher percentage of the company’s profits.
mezzanine financing
Likewise, mezzanine financing has a hybrid nature, distinguishing between equity and debt, and can create a significant financial burden due to its higher interest rates and complex terms. The terms and conditions of mezzanine financing may include covenants that limit the company’s operating flexibility, which may limit its ability to respond quickly to market changes.
Mezzanine financing is often chosen when a company cannot obtain the capital it needs through banks or other traditional lenders.
A common provision of mezzanine financing is that the debt reverts to equity under certain performance conditions specified in the agreement. Mezzanine investors may be able to take over control of a company if it defaults or underperforms. These factors may increase the risk exposure of the remaining partners, so terms need to be thoroughly understood and carefully negotiated to balance current capital needs with the long-term strategic integrity of the business.
The benefit of mezzanine financing, especially in real estate, is that equity partners can reduce risk exposure and realize high long-term returns. By reducing their upfront investment, partners rely on cash flow to pay down debt, while property appreciation increases the value of their shares in the business. When the property is paid off, they increase cash flow and, in the case of a sale of the building, they realize any gain, a one-time increase in value relative to the initial capital invested.
SBA-backed financing
An SBA loan may be an excellent option for businesses that qualify as small businesses by operating according to standards set by their industry. Through SBA 7(a) loans, businesses often qualify for more capital, longer repayment terms, and sometimes the same or lower interest rates than their traditional or alternative counterparts. SBA loan repayment terms can be extended to 20 or 25 years, so the monthly payments are quite reasonable. SBA loans can also be applied to a wide range of business costs, from real estate and equipment to lines of credit and working capital.
What are the disadvantages? The cost of debt can end up being higher than other types of financing. Additionally, SBA loans require some additional fees up front to cover the verification process required before the loan is approved.
SBA loans can be approved for partnership acquisitions, but are subject to strict scrutiny of business valuation and the type of business for which such financing is approved. Small Business Administration (SBA) loan applications are very detailed, and some businesses are denied simply because they don’t collect all the correct information. Brokers, such as our team, can significantly increase an applicant’s success rate by assisting in the proper packaging and review of loan applications before they are submitted.
Refinance
When a business is refinanced as part of an acquisition, both parties need to carefully consider the structure of the loan. Typically, to be approved, all partners need to sign to guarantee the loan. This means that if the business fails to pay its debts on time, the lender can personally go after all partners to obtain repayment. When a partner exits the firm, they don’t want to be held responsible if the remaining partners make a bad decision and go bankrupt.
In this case, alternative lenders are needed to finance the business without all partners guaranteeing the loan. Finding the right lender can be difficult, which is why a broker can be extremely helpful in preparing a successful loan package and matching you with the right lender. Typically, the transfer of assets, the leverage of those assets, and the acquisition of an ownership stake in the business are required at closing.
Work with a financing broker
When preparing for a partner acquisition, ensuring the correct financial arrangements are critical to ensuring a smooth and fair transition. Utilizing the services of a capital broker, such as our firm, can help you navigate the complexities of a partner acquisition.
Our team of experienced brokers will use our industry knowledge and extensive network to find the most appropriate source of funding for your unique scenario. By working with a broker, partners can simplify their financing search and obtain competitive terms and rates.
The broker will also help ensure that the financing structure not only meets the company’s current needs, but also its long-term business strategy. Working with a financing broker saves time and resources while reducing the risk of high capital costs and financing delays
A free, no-obligation conversation with our team can provide you with insights into the best financing strategies, whether through leveraged buyouts, mezzanine financing, or other creative capital structures. We’re here to support you on the next step in your business journey.
