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Financing a Business Purchase

Use debt to your advantage when structuring a deal.

Opinions expressed by Entrepreneur contributors are their own.

Q: I'm an inexperienced buyer who is seeking to purchase a manufacturing business. I would like some advice on how most deals are structured financially. I do not have deep pockets; therefore, I am looking for deals that don't require a huge initial cash investment on my part. What advice do you have?

A: I think it's important to first distinguish the difference between the cash paid to the seller at the closure of a transaction and your own equity infusion. The cash portion of the purchase price may include not only your personal cash investment, but also cash from other sources, such as financing you may obtain from a bank or other financing source. By utilizing debt as a resource, you can significantly increase your target price range to expand your purchase opportunities while still offering the seller enough cash at close to make the deal attractive.

In fact, the industry segment you're targeting-manufacturing firms-often has a strong chance of obtaining acquisition financing because of the asset base available for collateral purposes. Assuming the business generates sufficient cash flow to support debt servicing (and that the business is not already supporting a significant amount of operational debt), you should have a fair chance at attracting financiers.

There are several potential financing sources available for acquisition debt. One of the first sources to explore would be the Small Business Administration. Although you shouldn't rule out large commercial banks, you may have better luck with smaller, regional financial institutions, depending on the size of the transaction. There are many boutique financing firms that may be a good resource as well. If you have an established banking relationship, start there, as it's often easier to work with a bank that's familiar with your financial capabilities and loan payment record. You should also approach the target company's bank, which is likewise familiar with the performance track record of the firm you're purchasing. Finally, don't feel that a business with a minimal amount of hard assets is ineligible for financing. There are many lenders out there who are open to lending against the cash flow of the business.

With regard to deal structure, this can vary widely, even among offers for the very same firm. Deal structure can range from an all-cash transaction to an "all-earnout" deal, where consideration is paid only upon the achievement of future performance hurdles. In addition, it is not uncommon for deals in the small to midsized market segment to include a seller note as part of the structure. By "seller note," I am referring to a promissory note (with structured payment terms and interest) payable to the seller for a portion of the sale consideration. Keeping in mind that there is no such thing as a "typical" deal, as a rule of thumb, you can expect to put 20 to 50 percent cash down for an acquisition, with the remainder financed via a seller note or a deferred performance payout structure (earnout). Again, you may be able to reduce your equity contribution if you are able to obtain financing. If the asset base is strong, a seller may expect more than 50 percent cash at close.

Loraine MacDonald is director of advisory services at USBX, an investment banking firm specializing in the mergers and acquisitions of small to midsized businesses. She has been involved in the valuation and sale of privately-held businesses for over ten years. She can be reached at lmacdonald@usbx.comor at (310) 315-6700.

The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.