So, you just successfully negotiated your final price to buy out a competitor. You’ll be getting a small chain of stores, a reasonably-sized wholesale fuels and lubricants business plus a little heating fuel and propane. You’re feeling elated until the reality of your lack of cash sinks in. How are you going to pay for this?
Luckily, financing is still plentiful and you will have many options. Here’s a little wisdom to help you make the most appropriate choice.
First, decide what loan structure you will need before talking to any financing source. Consider:
1) Amortization – A good rule of thumb is to finance an acquisition over 15 years. Since the business is already up and running with cash flow, you should not need a longer term. Although some lenders will tempt you with 25 or even 30 year loans, remember that these can backfire if you need to make any significant improvements in the first few years of the loan. With real estate deflation, you could even owe more than your properties are worth!
2) Down Payment – Do you have any cash available to put into the deal yourself and if so, how much?
3) Type of Interest Rate – You will have a choice of variable or fixed rates. On longer term financing, it’s advantageous to lock in a fixed rate as long as it’s reasonable.
3) Personal Guarantee – Are you willing to personally guarantee the loan? If not, this will immediately narrow your field of lenders. There is no wrong or right answer here, just personal preference and a risk tolerance issue.
4) Collateral – exactly what are you willing to give? How’s the condition and marketability of the potential collateral? Would a lender want it?
5) Loan Covenants – From financial reporting requirements to specific ratio performance measures, what are you willing to live with? Is a page full of financial requirements unnerving to you or do you see the covenants as no concern since you have a strong financial position anyway?
Now, with your requirements and preferences clearly in mind, you can shop lenders. Here’s how they might stack up.
Owner Financing – This is usually your best deal if you can get it. Why? It’s normally cheap with very few strings attached. Potential drawbacks are too short amortizations and potentially dealing with a deceased owner’s estate. If you can negotiate the amortization, even with a stop or balloon if necessary, and then be sure your note documentation covers the “what ifs,” this will likely be your best bet.
Traditional Banks – If you have from 10% to 25% cash available for a downpayment, and don’t mind a personal guarantee, a traditional bank loan may be your best option. Expect them to want collateral and a loan agreement with financial covenants. Check out both variable and fixed interest rates, as well as checking out interest rate swaps (see article titled “Interest Rate Swaps”).
Specialty Mortgage Lenders – Most of these lenders would love to finance your stores, but have little or no appetite for wholesale businesses including bulk plants. By creatively valuing your stores, however, they may be able to do the deal taking only the stores as collateral. Although they don’t require personal guarantees, be prepared for fairly stringent cash flow covenants and higher rates and fees than most other lenders.
REIT – Real Estate Investment Trusts are cranking up and want your business. In this case, you sell your real estate to the REIT, and they lease it back to you. This works O.K. on store chains, but there are some risks involved. Remember, the REIT owns your properties! If you are in an area of increasing property values, the REIT may not be your best choice. Their advantage is 100% financing and pretty loose covenants.
Leasing Company – If your acquisition includes lots of equipment and rolling stock, don’t forget about leasing companies. They can work very well in combination with your real estate lenders.
Financing your acquisition can be painless if you know what you want, then go to bid with only those lenders you know can meet your needs.