Roll-Up Acquisitions III
Accelerate Your Roll-Up Strategy: Unveiling Financial Sources for Acquisitions
As a business owner aiming to expand through strategic acquisitions, you may be seeking reliable financial sources to fuel your growth. In this article, we will explore various funding options, including SBA 7(a) loans, and attempt to shed light on their requirements and restrictions. Whether you own a high-growth small business, a private equity backed company, or a medium-sized privately owned business, this comprehensive guide, the final in a series, will help you navigate the realm of acquisition financing and empower you to make informed decisions when choosing the right financial partner.
The Power of a Roll-Up Strategy
A roll-up strategy is an effective approach for consolidating multiple businesses within the same industry to gain market share, unlock synergies, and accelerate growth. Acquiring small businesses can be a key component of this strategy, enabling you to harness their existing customer base, intellectual property, or operational efficiencies. To successfully execute your roll-up strategy, it is crucial to secure the necessary funding through well-suited financial sources.
Funding Your Acquisitions
Traditional Bank Loans: A Reliable Option
Traditional bank loans remain a popular choice for financing acquisitions. These loans are provided by commercial banks and require a strong credit profile and collateral. While they offer flexibility in terms of loan amounts, repayment periods, and interest rates, securing a bank loan for acquisitions requires a strong credit profile, collateral, and a proven track record of business success. The application process can be rigorous, involving extensive documentation and a thorough evaluation of your financial standing.
Institutional Investors: Tapping into Operational Expertise
Collaborating with #privateequity or #venturecapital firms can be another avenue to fund your acquisitions. By partnering with these firms, you can leverage their financial resources, industry expertise, and operator network to drive successful roll-up strategies. However, it is extremely important to carefully consider the terms of the partnership, including ownership dilution, decision-making authority, and the long-term vision for your business.
SBA 7(a) Loans: A Forgotten Source
SBA 7(a) loans, offered by the U.S. Small Business Administration (SBA), can provide entrepreneurs with access to affordable financing for various business purposes, including acquisitions. These loans come with favorable terms, making them an attractive option for acquiring small and medium-sized businesses in the United States. They offer longer repayment terms, lower down payments, and competitive interest rates. These loans can be used for a range of purposes, including business acquisitions, working capital, and equipment financing.
To qualify for an SBA 7(a) loan, your business must meet specific criteria established by the SBA. These criteria typically include the nature of the business, size standards, good credit history, and the ability to demonstrate repayment capacity.
SBA 7(a) loans do however, require thorough documentation, including financial statements, tax returns, business plans, and personal background information. The application process involves a detailed review of these documents, as well as an assessment of your creditworthiness and business prospects.
While SBA 7(a) loans offer favorable terms, it's important to be aware of their restrictions. Some common restrictions include limitations on the use of funds, such as prohibiting the use of loan proceeds for real estate investment or debt refinancing. Additionally, the SBA may place restrictions on the type of businesses eligible for financing, such as certain industries or businesses engaged in speculative activities.
Frequently Asked Questions (FAQ)
Q: What is the SBA?
A: The SBA is a government entity. It is The Small Business Administration. The SBA is to lending, as the FDIC is to bank deposits. In essence, it is a guaranteed lending source for banks.
Q: Are SBA 7(a) loans only available to small businesses?
A: Yes, SBA 7(a) loans are specifically designed to support small and medium-sized businesses, including startups that are generating revenues, are profitable, and have tangible assets (inventory, receivables, real estate, etc.). Your company must also meet the size standards established by the SBA. These standards are convoluted and are tied to a combination of the NAICS code of the target company's industry and average size of annual revenues or the average number of employees. They've since offered a quick access standards tool however these frequently get updated and would advise working with your lending partner.
Q: Do I go to the SBA to apply for the SBA 7(a) loan?
A: No, you do not go directly to the SBA to get the loan. You are going to go to your local bank and approve your business loan subject to an SBA guarantee.
Q: What are some common terms of an SBA 7(a) loan?
A: The terms of SBA typically are, you are going to put 10-20% down. It’s typically at least a 10-year term with Prime + 2% interest. So, it’s not cheap money but it’s usually necessary in small and medium-sized business ownership.
Q: Can SBA 7(a) loans be used for acquiring multiple businesses?
A: Yes, SBA 7(a) loans can be used for acquiring multiple businesses as part of a roll-up strategy, as long as the businesses meet the eligibility criteria, and your lending partner is aware of the long-term strategy.
Q: I was under the impression SBA 7(a) loans required 100% ownership of the business post transaction close.
A: Yes, that is correct! However, and at the time of this writing, the SBA just released a significant SOP Change relating to ownership. Prior to the 2023 SOP Change, you could not do a partial change of ownership and were fully buying 100% of the business.
In the case of a partnership buyout, for example, Partner A with 40% equity interest could use the SBA 7(a) loan to buy out Partner B's 60% equity interest which would leave Partner A with a 100% ownership at transaction close. What you couldn’t do before the 2023 SOP Updates was for Partner A to buy 50% of Partner B's 60% equity interest, leaving a 10% seller note for Partner B to hold on full standby for up to 24 months of the loan term, which also was increased from 12 months; it was previously required for Partner B to no longer be involved in the business and not be considered a key employee of the company.
Q: Given the scenario above, and after meeting the loan requirement, what are some use case examples, all else equal?
A: As part of a succession plan or roll-up acquisition strategy, the next generation of family business leaders can acquire up to 80% of the company and the parents/sellers who aren't ready to leave but still want ownership in the company, can personally guarantee the loan by holding 20% of equity interest in the company.
Other use case examples include buyers who are long-time employees of the company. The sole owner wants to retire and wants to sell a significant equity interest in the company to his employees. He/she is fine being the loan guarantor while still having ownership in the company for the first 24 months of the loan term.
Q: What collateral is typically required for traditional bank and SBA 7(a) loans?
A: Traditional bank and SBA loans often require collateral, which can include business assets, real estate, or personal guarantees from business owners.
Q: How long does it take to secure financing through a private equity partnership?
A: The timeline for securing financing through a private equity partnership can vary depending on the relationship, negotiations, due diligence process, and legal documentation, but it typically takes several months. Similarly, for the #sbaloans and traditional #bankloans - do keep in mind, having a relationship with these financial partners, prior to submitting the letter of interest to acquire the business, affords a less stressful underwriting and faster due diligence process. This is where establishing an engagement with the Katalyst team can offer tremendous benefits and access to private credit lenders that specialize in SBA 7(a) loans.
Q: Can I create a capital structure that includes the SBA 7(a) loan with private equity funds?
A: In our experience, the problem using the SBA 7(a) loan with a private equity buyer is that the private equity firm would have to corporate guarantee the loan since they would own majority of the business post-close. Plus, most private equity firms have an investment period of 3-5 years and might be a mismatch with the longer-term SBA loan. However, with the recent credit crunch, there could be some willingness to financially consider a couple of workarounds to support a particular acquisition and its capital structure. This is where having an investment banker that has solid relationships with SBA lenders, private equity groups, and even venture capital funds could be critical to the deal structure.
Q: Can private equity firms and VC-firms provide expertise and support beyond capital?
A: Unlike traditional banks and SBA lenders, private equity firms often bring roll-up-your-sleeves industry expertise, financial engineering, operational knowledge, and strategic guidance to the table, along with their financial resources.
Conclusion
In conclusion, pursuing a roll-up strategy to expand your business through acquisitions also requires careful consideration of various financial sources. SBA 7(a) loans, traditional bank loans, and private equity partnerships each offer unique advantages and considerations. By understanding the requirements and restrictions associated with each of these funding options, you can make informed decisions that align with your growth objectives. Remember to consult with your team of experienced professionals such as an M+A investment banker, M+A transaction attorneys, lending partners, and even your estate planner to adequately guide you through the complexities of the roll-up acquisition process and help you secure the right financing for your growth strategy.
And if you need to establish relationships for SBA 7(a)lenders, please let us know during our intake process because we have a number of lenders that can help you.
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