Whether you own an existing business and are looking to expand, or you're wanting to start out in a new industry, business acquisitions can be an exciting opportunity.
If you already own an established business, in particular, buying out a competitor can be a great (and lucrative) way to grow market share—as an alternative to relying on slower, organic growth.
When you’ve already got the right infrastructure and networks in place, you can often strip out many of the running costs associated with the business you’re buying by integrating their systems with your own. In other words, you’re eliminating duplicate costs—whether that’s to do with systems or staffing or something else—to create a much cheaper and more efficient model.
It means you’re essentially taking on the top-line revenue without significantly increasing expenses, and in the process, adding a whole lot of value to your bottom line.
(Spotting these opportunities means having to have a finger on the pulse of what’s happening inside your industry—who your competitors are, and whether they’re open to selling. Or alternatively, you’ll want a good business broker who can do it for you. Get in touch if you’d like an introduction.)
But, there are a lot of moving parts to consider when looking at buying a business—particularly in terms of getting funding—and having the right people by your side is key to navigating the process.
Here, we'll break down everything you need to know about getting a business acquisition loan and other important factors to help make your acquisition a success.
A quick note on the importance of getting the right advice
Like any big financial decision, you’ll want to make sure you’ve got the right people around you to help guide you through the process.
There are a bunch of different things to consider when looking at a business acquisition. And the sorts of things you need to be thinking about will vary significantly depending on the nature of the company you’re buying.
The quality of the advice you get is going to vary significantly depending on who you’re talking to. If they don’t have the right experience—if they’re not specialists in your particular industry—they’re not going to have a good understanding of the risks involved, and how to mitigate them.
That’s a really important thing to think about when it comes to choosing your advisers, whether it be your lawyer, accountant, or loan adviser. It’s not a broad brush thing.
With that in mind, let’s jump in.
So, how do you put a price on a business?
There are two components to a business valuation.
The first one—which is the main thing you’re paying for when you buy a business—is something you often hear referred to as “goodwill”.
Goodwill encompasses all the intangible assets—including cashflow, and other things like brand, market share, intellectual property, and client base, which contribute to generating revenue. Basically, what you’re looking at here is whether or not the business model is proven, and whether historic cashflow is trending up or down over time.
The second part of the valuation looks at the physical asset base, which may or may not be significant, depending on the nature of the business. If you’re buying a company that leases out bulldozers, for example, there’s obviously going to be a large physical asset base to that. Less so (perhaps) if you’re buying a tech company, in which case quality due diligence around the intangible assets becomes even more important.
When you buy a business, the price is generally set based on a multiple of EBITDA (earnings before interest, tax, depreciation and amortisation).
The standard multiplier for most business acquisitions is 2 to 3 times—so if EBITDA is $500,000 for example, you’d pay somewhere between $1 million to $1.5 million—although it can depend on where the market is at, and whether someone is willing to pay that price.
If you’re buying a business with big recurring revenues or contracted incomes (think subscription-based tech companies or healthcare businesses with Ministry of Health contracts) where the client base is relatively sticky or income is virtually guaranteed, you may be looking at a much higher multiplier, potentially up to 8 or 9 times. You’d want to model things out of course, estimating a certain level of customer drop off over time—but for the most part that revenue is locked in, which is why you’ll pay more.
It’s always a good idea to get an independent valuer in—generally an accountant—to help you prepare an accurate valuation. And (as we’ve already touched on) you’ll want to make sure they’re specialists in the industry you’re buying in.
How much of the purchase price can I borrow?
It all comes down to the multiplier you’re buying at. The higher the multiplier, the more of your own money you’re going to need to front up with—a bit like when you buy a house.
As a rule of thumb, for a standard acquisition (where you’re buying at a multiple of two times EBITDA) the banks will usually be willing to lend up to 50 - 70% to an established business. Basically, because you’re buying at a lower multiplier, they’re more comfortable with you taking on a higher proportion of the purchase price as debt.
Once you start getting up into higher multiples—anything above three times EBITDA would be considered “highly leveraged”—it’s going to be much more expensive to service a 50% loan, and so the banks are going to require you to put in more of your own cash up-front.
What sort of funding options are out there?
Although there are non-bank funding solutions available, bank lenders are generally the preferred option in this space.
The reason for that is the fact that, while non-bank lenders tend to be more flexible in terms of their servicing requirements, they also require a lot more security and generally only offer funding on a 12 to 24 month term.
If you’re thinking about buying a business, you really need to have a good level of confidence around your ability to service the loan and meet your repayments.
So, while in some cases, a non-bank lender may be the right fit, if you’re having to go down that route to make it work (especially when you’re just starting out) chances are it’s a bit too much of a stretch.
Pretty recently, we’ve also started to see the emergence of other alternative funding options—including private credit funds—for businesses that perhaps don’t quite meet bank requirements. It's a relatively new space in New Zealand, but one that’s likely to grow in the coming years.
If you’re keen to understand the different funding options out there, and which might be right for you, get in touch with our team of specialist advisers for a chat.
What kind of terms can I get on a business acquisition loan?
The maximum term most banks will go to on a business loan is five years—although BNZ has recently started to offer funding on a 10-year amortising basis. To get that sort of term, you’ll need to be able to clearly show that the business model is proven and present a good case as to why you need the money for longer.
Rates can vary significantly based on the level of risk involved for the lender, so the stronger the security profile, the cheaper the money is going to be. An indicative range for bank funding would be around 8% for a really well-secured business, up to around 9.5% at the riskier end of the scale.
What sort of security are lenders looking for?
There are two main types of security when it comes to a business acquisition.
The first is to do with the tangible asset base. Lenders will generally require you to sign what’s known as a General Security Agreement, which gives them the right to sell off any physical assets in the event the company goes under before the loan is repaid.
If you’re buying a business with a lot of large physical assets, that’s going to give your lender much more comfort, which is going to help you secure more favourable loan terms.
If the business doesn’t have a lot of physical assets, however, the bank may want to see you pay your loan off in a shorter timeframe—and you’ll need to really dive into the cashflow side of things to make sure that historical revenue is sustainable going forward.
The second part of the security equation is the personal guarantee.
You’re almost always going to be required to sign a personal guarantee when you take out a business loan, but you want a good loan adviser who’s going to be having conversations with your lender to agree a point where they’ll be happy for that to be removed.
Generally, that looks like getting to a lower leverage position. Once you’ve chipped away at the loan balance and got it down to somewhere between 1 to 1.5 times EBITDA, where the business can afford to pay off the remainder of the loan in a year to a year and a half.
How are business acquisition loans structured?
In some cases, it may make sense to structure the loan on a purely standalone basis, where the business itself takes on the entirety of the debt as a business loan.
You can also choose to split the loan and take on some of the debt on an individual basis—for example, by leveraging existing equity in your home (or other assets) to help fund the purchase price.
The benefit of going down the latter route is that you’ll generally be able to get far better terms on the personal portion of the loan, including much cheaper rates, longer loan terms (up to 30 years), and interest-only payment options.
Splitting the debt also means you can focus on paying down the business portion of the loan initially—getting rid of the more expensive debt as quickly as you can—then potentially look to restructure the remainder of the loan once that’s been paid off.
If you’re considering taking out part of your business acquisition loan in an individual capacity, you’ll need to be mindful of the potential impact of new debt-to-income (DTI) rules introduced earlier this year, which limit the amount you can borrow based on a multiple of your income.
Generally speaking, though, once you’ve factored in the income you’ll be taking home from your new business (how much you’re going to pay yourself) that should help to ease things up a bit from a DTI perspective.
What other considerations will lenders have when looking at funding a business acquisition loan?
Your lender is going to want a good level of comfort in your ability to keep the business running as it has previously, once you take over. Have you got the right experience, both within that particular industry, and when it comes to running a business in general?
Part of what they’ll be looking at here is the strength of your personal financial position. If you’re older and don’t own your own home or have a decent level of savings, for example, that’s going to raise some questions for your lender around your ability to run a business.
They’ll also want to see that you’ve got a good transition plan in place, ideally where the current owners have agreed to stay on in the business for a certain period—usually up to a year—in a paid capacity, to show you the ropes.
A good way to manage this is to include an earn-out clause, which stipulates that if the business performs to an agree level over that transition period, they’ll get a bigger pay-out. That can really help to keep the previous owners engaged.
Your transition plan should also consider the wider team. Have you thought about key man risk? Are those key members of the team planning to stay on after the acquisition? What are you doing to keep them i.e. share schemes or bonus structures? And what’s your plan if they do decide to leave?
Last but not least, your lender will want to see that you’ve got a good understanding of the potential risks involved in that particular industry, and with running a business in general. And that you’ve got a plan in place to mitigate those risks.