Most buyers who are looking to acquire a business will need or want to secure third party debt financing to maximize the leverage of the business assets and cash flow and minimize their down payment.
Put it another way, all cash purchases are fairly rare with respect to business acquisitions. Even if an individual or company could pay cash, they will likely want to cover off some of the purchase price with debt capital in order to reduce their weight cost of capital.
But business acquisitions can be very difficult to finance with third party debt, even if the required business loan amount is only a small portion of the total funds required.
There are several reasons for the high degree of difficulty securing business loans, far too many in fact to effectively cover off here. Instead, we’re going to focus on one of the key things that kill many business acquisition financing applications and that’s the historical financial statements provided by the vendor.
First, a lender will want to go back at least 3 years, but would prefer a longer view of historical performance. The longer term view of the business may not support the repayment analysis, especially if the near term results are stronger than those 3 or 4 years ago.
Second, especially with smaller businesses, the historical financial statements are done under a notice to reader accounting statement, providing very little if any third party verification of the results shown. For acquisition loan requests, especially those based highly on cash flow, lenders will not rely on notice to read statements.
Third, its not uncommon for the vendor to pull out all the stops the last year prior to sale to make the statements appear as good as possible which can also distort them compared to long term results, creating a lack of lender confidence in the financing opportunity.
Fourth, vendor’s may have several strategies to withdraw cash out of the business to save on both business and personal taxes. These strategies may not be easily identified in the historical results and while the vendor can disclose them so a lender can add them back, vendor’s tend to only focus on what was actually reported.
Fifth, if the business has some amount of cash sale component, its not uncommon for the vendor to not report all sales. The result is that the financial statements understate the real financial performance of the business.
While the buyer is the one trying to secure the financing, the ability to do so will correspond directly to how much the vendor has invested in the historical financial statements. And the ability for the vendor to secure the highest possible sale price is going to likely depend on debt financing which will once again be influenced by the historical financial statements and the accompanying support information.
The key take away is that spending money on a higher level of accounting opinion and bookkeeping that can be more easily verified by the buyer and third party lenders should be considered an asset that can generate a substantial return by allowing the buyer to not only secure debt for the purchase, but a higher level of debt so the down payment does not have to be as substantial and higher purchase prices can be considered.