With the specialization of the financial markets in the United States, most institutions provide only limited types of financing. Approaching the wrong type of financial institution for financing is a waste of time and effort. Your VR intermediary can guide you to the appropriate options.
Financial institutions have criteria for acquisition lending, which takes into consideration such factors as a company’s size, the stage of its growth and its potential for further expansion, its location, the industry that it is in and its financial strength.
The financial world is broadly categorized into lenders, investors and development financing institutions. Lenders lend money-debt, in their parlance-for a specified period at a given interest rate. They expect regular payments of principal and interest. Investors buy equity-a share of ownership in the business. They typically expect to get their original investment and return on it back through sale of stock at a later date. Development lenders, usually Federal, state or local agencies with a mandate to promote certain forms of economic activity, may offer debt, equity or a combination of the two.
Bankers are normally risk averse because they do not charge enough to compensate for high risk. Bankers usually lend on the basis of the company’s historical and projected cash flow, debt service capability, guarantees and collateral.
Venture capitalists, essentially investors who put their money in startups and emerging businesses, and so-called angels, rich individuals who do the same thing, are hard bargainers. If they like your company they will demand a big chunk of the equity.
Development-finance sources offer cheaper financing for the purpose of achieving social benefits like creating jobs, promoting exports, developing technologies, assisting minority citizens and spurring moribund local economies. If the business you wish to acquire offers any of these benefits, inquire to these sources.
Your Needs - Lender’s Goals
You need to match financing sources goals to your needs. Lenders have different capacities to finance and absorb risks. As you go about your search, here are some ground rules to bear in mind:
- If you are seeking debt financing, borrow against fixed assets like equipment and real estate, rather than against cash flow.
- Use your equity for working capital.
- Finance short-term assets, such as working capital, with short- term debt, such as line of credit, and finance long-term debt. Short-term debt should never be used to acquire long-term fixed assets.
- It is nearly impossible to raise debt financing to acquire a company showing losses; selling a stake in your venture is about the only way to get money for that purpose.
If your acquisition needs correspond to the goals of the investing or lending institution, raising money becomes easier.
Family and Friends
Without a proven track record, family and friends are often called upon to invest in the acquisition of your new business. Their investment in you will help secure additional financing from institutions. Common options to obtain financing from family and friends are common stock, or equity, and subordinated debt with equity features.
Lenders Come in Many Forms
Know the different types of institutions that lend money. Understand how lenders expect to be repaid, and how they reduce risk:
- Commercial banks. They do all types of loans, but they don’t take risks and they can’t spend large amounts of time with any single customer.
- Commercial finance companies. They provide working capital to companies that are experiencing growth in inventory and accounts receivable.
- Leasing companies. They finance equipment by renting it out for a fixed period of time.
- Suppliers. They are primary sources of credit. Make sure that you have a good credit rating and that suppliers are aware of it, since the cost of credit is built into their pricing.
Lenders expect to be repaid through the cash flow of the business.
Collateral can include inventory, accounts receivable, equipment, real estate, stocks and bonds and savings accounts, in short, anything of value that could be sold to pay back the loan.
In seeking a loan, you should be familiar with loan-to-value ratio, which lenders use. Here are some common loan-to value ratios:
- For inventory: Generally, they will lend between 25% and 50 % of the value of finished goods but will lend up to 80 percent of the value of certain commodities.
- Accounts receivable: up to 80 percent if the billing terms are reasonable, the customers are credit-worthy and the accounts are current.
- Equipment: up to 75 percent, depending on how easy it would be to sell it, and up to 100 percent for leases.
- Real estate: up to 75 percent for most general-purpose real estate, depending on cash flow; some government programs will lend up to 90 percent.
You should also know about cash-flow ratios:
- Times interest earned, or the ratio of your projected earnings to your interest-payment obligations.
- Fixed charges coverage, or the ratio of cash available for payment of principal and interest to your principal and interest.