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Affordable financing for acquisitions: don't miss reasonably-priced acquisition opportunities because you think that financing is not available.

Securing acquisition financing is more challenging than before 2008 but far from impossible to attain. Acquisition pricing is now reasonable and interest rates are affordable. Quality franchised resale opportunities are being priced between four to 4.5 times EBITDA. This range allows for solid returns on investment versus the deals that were sold for six, seven or even eight times EBITDA in the past.

Taking advantage of today's acquisition opportunities requires more equity injection and the effort to search out lenders who are ready, willing and able to lend. Just contacting the short list of large or regional lenders who have supported acquisition financing in the past may not be enough. Let's review a range of strategies to secure acquisition funding for smaller, as well as large transactions.

SBA Lenders

For enterprise transactions requiring $2 million or less in financing, Small Business Administration-backed loans are still a viable source of funds. Under the current programs, passed by Congress, 90 percent SBA guarantees are provided to banks. Also the loan guarantee fee paid to the SBA has been waived. This will save you up to 3.5 percent of the loan amount at closing. We have secured funding for many of our transactions over the last year and a half using the following approach.

* Offer a cash injection equal to 25 percent of total project cost. Given the reasonable price range of acquisitions, cash-on-cash returns of at least 33 percent is typical with this level of injection.

* Plan on a variable interest rate of 6 percent (2.75 points over the prime rate).

* Require a 10 year loan term with no pre-payment penalties.

* Do not just rely on regional SBA lenders. Take the time to contact the following categories of banks (in priority order).

1. The bank with which you conduct daily business.

2. Regional or local banks located in the same geographic area as your acquisition opportunity.

3. Community banks outside of the geographic area of your acquisition.

Banks are very focused on their own balance sheet issues. Be prepared to provide a personal loan guarantee and additional collateral beyond the business assets included in the acquisition. Sources of additional collateral may include:

1. A second position on real estate you own.

2. A second position on real estate owned by a close and willing family member.

3. A certificate of deposit deposited with the lender.

* If you do not have the ability to provide additional collateral you may consider taking on one or several minority partners. It is important to note that the ownership interest of investing partners must be less than 20 percent to avoid a personal loan guarantee by the partner(s).

* If real estate is included in your acquisition, 504 financing programs are available through SBA lenders. Real estate loans of up to $5 million are available through this SBA program. A blended loan term of about 22 years at interest rates of 6.5 percent to 7 percent is typical.

* Third party appraisals will be required for all real estate as well as the business value.

* Plan on a 45 to 60 day period to complete the approval process and for the loan to be funded.

* Offer to do your business banking with the bank if the loan is approved.

Conventional (non SBA) Loans of Less than $5 million

We have secured conventional financing for transactions by utilizing the following approach.

* Offer a cash injection equal to 35 percent of total project cost. Given the reasonable price range of acquisitions, cash-on-cash returns of 25 percent to 30 percent are typical with this injection.

* Take the time to contact the following category of banks (in priority order).

1. The bank with which you conduct daily business.

2. Regional of local banks located in the same geographic area as your acquisition opportunity.

3. Community Banks outside of the geographic area of your acquisition.

* Require either a seven-year loan term or 10-year amortization with a seven-year balloon payment.

* Plan on a fixed interest rate of 7.25 percent to 7.5 percent for enterprise loans.

* Make sure that the fixed charge coverage ratio is about 1.50. If this ratio is below 1.50, plan on injecting additional equity which will reduce the loan amount. The fixed charge ratio is determined by dividing EBITDA plus rent by debt service plus rent.

* Be prepared to provide a personal guarantee (the lender may require).

* If real estate is included in the acquisition, plan on a 15-year loan term with a 10-year balloon payment.

* Third-party appraisals will be required.

* Offer to do your business banking with the bank.

Conventional loans of more than $5 million

For loans in excess of $5 million, the number of lenders is limited to large institutions. While their lending criteria are more restrictive, they are lending. Loans should be pursued understanding the following will be required to ensure approval.

* Cash injection of 35 percent to 40 percent of the acquisition price plus soft costs. Soft costs include due diligence expenses, loan fees and inventory. Even with this relatively high-equity injection, cash-on-cash returns will be at least 25 percent based on current EBITDA multiples.

* Fixed charge coverage ratios ranging from 1.35 to 1.50.

* If you do not have the ability to provide the full 35 percent to 40 percent cash injection there are private-equity firms or mezzanine funding firms that have funds to invest and are actively looking to place funds. These options will be discussed in detail later.

* Plan on a seven-year loan term or 10-year amortization with a five to seven year balloon payment. If real estate is included, a 15- to 20-year loan term is likely with a 10-year balloon payment required.

* Plan on a fixed interest rate of 7.5 percent to 7.75 percent.

* Both business and real estate appraisals will be required.

* If the loan amount exceeds $10 million the lender may want to partner with other lenders to provide loan proceeds. The reason is lenders ate more focused today on borrower concentration. The large lenders will reach out to other lenders to achieve the partnering. You will not have to pursue multiple lenders yourself.

Mezzanine Funding

Mezzanine financing may be used to enhance your equity injection. Mezzanine financing is subordinated to the senior lender's debt and is usually structured with a small equity component.

Mezzanine financing is a more expensive financing source than senior debt with interest rates ranging from 12 percent to 16 percent. The payments are generally interest-only thus allowing reasonable debt service. The equity component is something that must be negotiated. The minimum investment for groups providing this type of funding range from $3 million to $5 million. The payoff of this financing is usually accomplished by a combination of internally generated cash flow and refinancing with senior debt. Refinancing is easier to achieve once the acquisition results have matured and ate documented.

Private Equity

This type of capital is available to experienced operators who have the ability to also inject capital or have existing operations to combine with the acquisition. Because current return is more important than a longer term investment in today's market, private equity groups are beginning to look at this type of investing more favorably.

Equity groups may be informal, such as a few high-net-worth investors getting together to invest or established private-equity firms. These investors are looking for an annual return on their investment of 25 percent to 30 percent, usually within five to seven years. The amount of equity participation required will depend on the amount of their injection versus the operator's contribution. These firms are also excellent sources of funding for management buyouts. Since the management team will be leveraging their experience and track record versus significant cash injection will not be required, 10 percent is typical.

The smaller equity groups may be satisfied investing a minimum of $1 million to $2 million. The larger groups will only consider investments of at least $5 million.

Acquisition-opportunity pricing for quality franchised operations is reasonably priced, typically ranging from 4.0 to 4.5 times EBITDA. While a lower level of leverage will be provided by lenders in today's lending environment the pricing multiples allow for cash-on-cash returns of 25 percent to 35 percent even with more equity injection. If necessary, either mezzanine financing or private equity is available to supplement buyer injections.

Do not miss out on the reasonably priced acquisition opportunities available today because of a misperception that financing is not available.

Gene Cerrotti is CEO of the Praetorian Group. He can be reached at 888-358-3325, Ext. 226 or genec@praetoriangroup.net.
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Title Annotation:FINANCE
Comment:Affordable financing for acquisitions: don't miss reasonably-priced acquisition opportunities because you think that financing is not available.(FINANCE)
Author:Cerrotti, Gene
Publication:Franchising World
Geographic Code:1USA
Date:Sep 1, 2010
Words:1434
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