Financing of a business acquisition

There are often various options for financing a business acquisition. Sometimes it is even necessary to draw on multiple financing options. Not all entrepreneurs who want to acquire a business have sufficient financial resources. Start-ups in particular often need external capital or external financing. In addition to the costs of financing, it is also important to consider the form of financing. On this page, we discuss the process and the various options for financing a business acquisition.

Financing a business takeover

Taking over a business often requires a substantial investment. The total amount of the takeover sum paid in a business takeover consists of the costs of the items and assets being taken over, such as real estate, machinery and stock, but also goodwill. Goodwill is a symbolic amount paid for, among other things, the company’s good name, its customer base and its reputation. Structuring financing for a business acquisition is a complex, often lengthy and intensive process. Although each acquisition requires its own approach and tactics, the financing process is broadly similar. There are various methods of financing a business acquisition.

Forms of business acquisition financing

The best-known form of business acquisition financing is financing through a bank, a bank loan. For a smaller short-term loan, one can take out an overdraft facility. Entrepreneurs are allowed to be “in the red” up to a certain amount. There is no (direct) repayment obligation and interest is only paid on the amount actually withdrawn. However, the company often needs the overdraft facility as a backup for its own business operations. The overdraft facility then provides too little scope to finance an acquisition.

For the financing of acquisitions, separate credit agreements are therefore often concluded with banks. This is a credit facility or business loan that may be used specifically to finance the business acquisition. Separate agreements with the bank apply in this case with regard to interest, repayment, term and collateral. The company, vision, strategy, what a buyer is financing and any financial contribution from the seller are also examined in detail. Financing is also highly dependent on the situation of the takeover. For example, in the case of a gradual takeover of a company, different arrangements are made. It is also possible to combine different financing options.

Crowdfunding by private investors

In addition to bank financing, there are now various (alternative) forms of financing for a company takeover. One way to involve more private investors in a company is crowdfunding. Unlike banks, which look at past financial figures and the buyer’s creditworthiness, private individuals and alternative financiers mainly see the opportunities and potential returns as the basis for their investment. In addition to potential, crowdfunding also looks at the goodwill factor of entrepreneurs seeking financing for a business acquisition. A good story, vision and commitment can convince lenders.

For larger amounts, the bank will usually ask for a guarantee or other form of security. This can be a personal guarantee from the company’s shareholder, but also a mortgage on the company’s property or a pledge on shares or assets. Although bank financing is a cumbersome process, the advantage of this method of financing a company takeover is that the buyer does not relinquish any shares or control.

Agreement with owner

In some cases, the seller of a company is willing to make a payment agreement with the buyer to finance a company takeover. For example, through staggered payments or an earn-out arrangement, so that the total purchase price does not have to be paid in one go. Often, a substantial deposit is made and the remaining amount is paid in instalments. Another option for financing a business acquisition is for the current owner to provide a subordinated loan or for the seller to receive a share of future profits.

Subordinated loan for business acquisition

In practice, it is not unusual for a seller not to receive part of the sale price directly from the buyer when the acquisition agreement is concluded. The part that is not paid immediately is then converted into, for example, a loan from the selling party to the buying party. In practice, this loan is also sometimes structured as a subordinated loan.

This loan counts as equity and in many cases must be subordinated to the loans of other creditors, such as the loan financed by a bank for the acquisition. In short, this means that the other loans must be repaid first before the subordinated loan can be repaid.

Advantages and disadvantages for the selling party

Banks often take a critical view of financing a company takeover. Taking out a subordinated loan can help a selling party to speed up or complete the sale. In practice, however, this does not happen very often.

By contributing to the financing of the company takeover themselves, the seller can dispose of the company more easily and quickly. This form of financing a company takeover also has a number of disadvantages for the seller.

In the event of default, the seller often has nothing to fall back on. In addition, the seller also has to wait much longer to receive the entire purchase price. A subordinated loan means that other financiers, such as the bank, have priority over the repayment of the seller’s loan. If a company goes bankrupt, the seller will be the last to be repaid. It is therefore obvious that the seller should thoroughly investigate the buyer and the business plan of the intended new owner before granting the loan.

Advantages and disadvantages for the buyer

A loan from a selling party is attractive to the buyer in several respects. Not least because the fact that the seller is granting a loan means that there is confidence in the new owner of the company. When considering a financing application, interested financiers examine the ratio between equity and debt. A subordinated loan is regarded by financiers as equity.

As part of the loan, the buyer and seller can make agreements about profit rights. When granting a subordinated loan, the selling party retains the right to a percentage of the profits for a certain period after the takeover. In many cases, profit rights are combined with a fixed takeover price.

Another way to realise a sale using this loan is to draw up an earn-out arrangement. In this case, the buyer only repays the loan or part of the loan once pre-agreed turnover or profit targets have been achieved. A risk for the buyer in this type of business acquisition financing is that the selling party will continue to exercise control over business operations and investments in an attempt to achieve the maximum earn-out bonus.

Financing a business acquisition through private equity

A private equity investor is a collective term for investors who invest in unlisted companies. This form of financing for business acquisitions is used for specific investment scenarios, such as:

• the growth of an unlisted company;

• privatisation of a company by the existing management (management buy-out);

• continuation of a company with new managers (management buy-in, MBI);

• privatisation of a business unit (divisional buy-out);

• delisting a company from the stock exchange (public-to-private);

• bridge financing;

• restructuring;

• financing start-ups (venture capital);

How to finance a company takeover

When considering a loan to take over a company, people quickly think of the bank. This traditional way of financing a company takeover is no longer the only option. Nowadays, there are many more modern forms of financing that make financing a company takeover a success.

In practice, we are increasingly seeing a mix of financing methods being used for company acquisitions. The bank finances part of the acquisition, the buyer finances part of it themselves, and the seller lends part of the acquisition sum to the buyer. The government can also offer support in financing a business acquisition. The government has established guarantee schemes for various types of business acquisitions, such as international business acquisitions, family business acquisitions and acquisitions of businesses in developing countries. A government guarantee can, among other things, help in obtaining a business loan from banks.

A step-by-step plan for a business acquisition

The successful completion of a business acquisition requires good preparation and a clear step-by-step plan. Once you have decided on the company you want to acquire, a step-by-step plan for a business acquisition looks like this:

Step 1: Sign a confidentiality agreement

Step 2: Introduction between buyer and seller

Step 3: Exchange of information (sales memorandum)

Step 4: Valuation and takeover bid

Step 5: Negotiations, guarantees and indemnities

Step 6: Draft and sign a letter of intent

Step 7: Organise financing for the business acquisition

Step 8: Due diligence investigation

Step 9: Draft business acquisition contract

Step 10: Payment and transfer

A step-by-step plan for business acquisition provides a general overview of the entire process. A business acquisition solicitor will assist buyers and sellers throughout this process. Of course, a specialised lawyer provides comprehensive guidance to the parties: from advice on a business acquisition and determining the business acquisition arrangement to drawing up a business acquisition step-by-step plan and organising the financing of the business acquisition in order to ensure a successful business acquisition.

Taking over staff in a company takeover

When taking over a company, there is an obligation to take over employees. The new owner may not change the rights and obligations of employees. The existing employment contracts and agreements with the former owner remain in force. More information about the obligations of the buyer in a company takeover and the rights and obligations of staff in a company takeover can be found on this page. A company takeover, but staff do not want to come along? In this article, we give you tips on how to deal with this.

What are the legal consequences if agreements in the company takeover contract are not complied with?

Failure to comply with agreements in the business acquisition contract can lead to significant legal and financial consequences. These include compensation, repayment obligations or even termination of the agreement. The contract often includes guarantees and indemnities: if these prove to be incorrect – for example, regarding debts, staff or contracts – the buyer can hold the seller liable. Penalty clauses and procedures regarding compliance or rectification of defects are also common. Take compliance seriously, include clear sanctions in the contract and ensure that all obligations are realistic and feasible. This will prevent protracted conflicts that could undermine the success of the acquisition.

Advantages of business acquisition financing Fruytier

Acquiring or selling a business is a challenging but also complicated process. A comprehensive scan of the company, also known as due diligence, can be of enormous help in this regard. Fruytier’s corporate law solicitors have extensive experience in this area, both with large (listed) companies and with purchases or sales in the SME sector. Our specialists offer excellent guidance for every type of business acquisition and provide targeted, well-founded advice on business acquisitions.

It is important to seek sound advice when drawing up a financing agreement for an acquisition. As a specialist in mergers and acquisitions, Fruytier Lawyers in Business offers committed guidance on company acquisitions. We provide clients with targeted legal advice based on years of experience as M&A specialists. In our role as business acquisition advisers, we are happy to advise you on the best tactics for buying or selling and determining the right form of business acquisition financing. For more information or tailored advice, please contact a business acquisition solicitor at Fruytier Lawyers in Business!