How an Acquisition Loan Works

Acquisition loans work on the principle that the acquirer purchases the target with a loan secured by its properties. An acquisition loan can come from one or more banks. The acquirer must first ensure that the target's assets are sufficient collateral to receive an acquisition loan. The acquirer must also develop and analyze financial forecasts for the merged companies to ensure that they produce enough cash to pay the principal and interest.

Obtaining acquisition loans is often costly and challenging, and when a transaction is significant, there are often several acquirers, which allows for risk and expense sharing (and rewards). Maintaining optimal cash flow can be difficult in some situations if the target's management team leaves after the acquisition. To properly structure the loan and trade, a company usually needs an investment bank, a law firm, and third-party accountants.

Acquisition Loan Example

Company A wants to expand its resources and market reach and decides that the best way to do this is to acquire Company B. Company A needs a loan to help them cover the acquisition fees so they go to their local bank. The problem is, Company B is facing possible bankruptcy and so it is a major risk. Company A is able to make the argument that their profits and the combined resources will cover the interest rates and principle of the loan—Company B isn't bankrupt yet! The bank reviews the assets and financial trajectory of the company and approves the loan request. Company A can now acquire Company B.

Types of Acquisition Loans

There are various kinds of acquisition loans, and there are different types of acquisitions that require different needs. Some of the most common acquisition loans available to businesses and individuals are as follows:

Startup Loan

You can apply for a startup loan if you don't own a company but want to buy one. Standard banks, the Small Business Administration (SBA), and other lenders offer startup loans. You may be required to demonstrate to the lender that you have the expertise and abilities to run a company before being accepted for a startup loan, and you will be required to make a deposit.

Small Business Administration Loan (SBA)

SBA loans are backed by the SBA for up to 85% of the loan amount, making them less risky if the borrower defaults. It enables a borrower to get better loan interest rates and payment terms.

The Small Business Administration (SBA) has a comprehensive system to help borrowers find the correct lender and any other assistance they may require during the process.

Business Expansion Loan

People who already own and run a company have access to this type of loan. It enables the lender to assess how dangerous the prospect of lending is firsthand. It also helps the lender evaluate the borrower's ability to operate a profitable company and repay it.

It is common for the lender to know that the company has been in service for a particular time before the lender considers extending funding for a business expansion.

Equipment Financing

Equipment financing is not a form of a loan but rather a type of financing with some restrictions to buy business equipment. For example, in equipment financing, the asset purchased serves as collateral for the loan. It eliminates the need for extra collateral or a rigorous credit check in some instances.

Significance of an Acquisition Loan

An acquisition loan aims to make a big purchase without investing a lot of money, but the ultimate goal is to boost the shareholder value. Most shareholders believe that the debt is worth the trouble if the transaction produces a more robust, more effective, and profitable company. However, if debt levels are too high or synergy isn't present, the company can't service its debt and will face bankruptcy.

Because of this high degree of risk, stock prices typically collapse when a company announces a large-scale debt acquisition. Nonetheless, this may be a buying opportunity if investors believe the company will be able to repay its debt, increasing the value of its stock.

When interest rates are low (which lowers the cost of borrowing and allows investors to pursue high-return opportunities), and when the economy or a specific market is underperforming, the demand for acquisition loans rises typically. Thus, company values fall. Nevertheless, an increase could signal more deal competition, which tends to drive up the price of targets, increase the amount of debt required for acquisitions, and raise the risk that the merged company would be unable to meet its debt obligations.