How a small acquisition actually gets paid for

Three sources, and none of them cost only their rate

Money in a small acquisition usually comes from three places, often all three at once, and the mix matters more than any single term.

Your own cash costs nothing in interest and everything in flexibility. Every dollar committed at closing is a dollar not available in month seven when something breaks. The real cost of paying more cash is the reserve you no longer have.

Borrowed money costs interest, and also costs conditions. Personal guarantees, security over assets, reporting obligations, restrictions on further borrowing, and a timetable that is not yours. A lender's requirements shape a deal long before the first payment is due.

Seller financing, where part of the price is paid over time by the seller taking a note, costs interest as well, and it buys something the other two cannot. It keeps the person who knows the business financially interested in your first year going well.

Sources and uses, on one page

This is the most useful page in an acquisition file and it is one most first-time buyers do not produce until somebody asks for it.

On the left, every dollar going out: the purchase price, the fees, the working capital the business needs from day one, and a reserve. On the right, every dollar coming in: your cash, any borrowing, any seller note. The two sides must be equal, which is the whole discipline. A deal that does not balance on paper does not balance in reality either. It simply fails later and with less warning.

Build it before you talk to anybody about money. It converts a vague sense that a deal is affordable into a specific set of numbers, and the first time you build one you will usually find the gap is larger than expected, because of the next section.

Working capital is the line people forget

A business does not stop needing money the day it changes hands. Payroll still runs, suppliers still invoice, and customers who paid the previous owner on thirty day terms still pay on thirty day terms.

A buyer who funds only the purchase price and the fees can find this out early, and at a bad moment. The business is not failing. It was simply never handed over with the cash it needs to keep operating, and that cash has to come from somewhere.

How much is needed depends entirely on the business: how quickly it collects, how much stock it carries, how seasonal it is, and how the previous owner was funding the gap. Work it out from the actual pattern in the statements rather than from a rule of thumb, and put the answer on the sources and uses page as its own line.

Debt service is a monthly question

The following figures are illustrative. They are invented to show the arithmetic and describe no real business or loan.

Suppose the earnings you actually believe, after the adjustments you tested, are 120 thousand dollars a year. Suppose the borrowing works out to 3 thousand dollars a month, so 36 thousand a year. Suppose you also need to pay yourself 60 thousand to keep the household running.

That leaves 24 thousand a year of headroom, which sounds tolerable annually and is roughly 2 thousand a month. Now put a slow quarter, one equipment failure and one late-paying large customer into that picture. The annual figure survives it. The monthly one may not, and the payment is monthly.

This is why lenders look at coverage rather than at profit, and it is why the exercise is worth doing yourself before anybody does it to you. The number that matters is not whether the deal works. It is how much has to go wrong before it stops working.

A seller note does more than fill a gap

Where a seller agrees to be paid part of the price over time, two things happen. The obvious one is that you need less money at closing. The less obvious one is that the seller now has a reason to care whether the business does well after they leave.

That alignment is worth negotiating for even where you could fund the whole price. It changes the tone of the transition, and it gives you something to point to if the business turns out to be materially different from what was described.

Terms vary widely and interact with any other borrowing you are doing. Whether a lender will accept a seller note alongside their facility, on what terms and in what position, is a question for that lender rather than a general rule, and the answer is not the same everywhere.

What a lender is deciding, and why answers vary

Strip away the paperwork and a lender is asking three things. Does this business produce enough cash to make the payments with room to spare. Is there something to recover if it does not. And is this buyer likely to be able to run it.

That last one surprises people. Relevant experience, or a credible plan for who supplies the experience you lack, is part of the assessment rather than a formality.

In the United States a lot of small acquisition borrowing involves the Small Business Administration's guarantee programs, which are often described as if they were a single fixed rulebook. They are not. Program requirements are revised over time, and every participating lender applies its own credit policy on top, so two lenders can reach different answers on the same deal. The workable approach is to ask a specific participating lender for their current written requirements, and to confirm anything you have been told secondhand before building a plan on it.

What to have ready before the first conversation

You will be taken more seriously with four things assembled, and assembling them is useful even if you never send them.

The sources and uses page. The earnings figure you believe, with the working shown for how you got there from what the seller reported. A short statement of your own financial position. And a plain description of who will run this business day to day, including which parts you have done before.

The purpose of arriving prepared is not to impress anybody. It is that the questions a lender asks are the questions you should have already asked yourself, and finding a hole in your own file is much cheaper than having somebody else find it.