Preparing for acquisition financing: what lenders need to believe

Start with the question lenders are really asking

Every acquisition lender, regardless of size or type, is trying to answer one question: will this business, under this buyer, reliably generate enough cash to service the proposed debt, with room to absorb a bad year?

That question breaks into three parts. Is the target's historical cash flow real and repeatable? Is the proposed structure reasonable relative to that cash flow? And is the buyer credible as the person or team who will run the company after closing? Preparation is the work of answering all three, clearly and consistently, before the first lender meeting.

Establish the quality of earnings

Seller-prepared financials often present earnings with add-backs: owner compensation above market, one-time expenses, personal items run through the business. Some add-backs are legitimate; others will not survive scrutiny. Lenders discount what they cannot verify.

Before you set a price, or at least before you finalize one, understand which adjustments are defensible and supported by documentation. For larger transactions, a third-party quality of earnings review can be worth its cost simply by preventing a mismatch between price and financeable earnings late in the process.

• Reconcile tax returns to internal financial statements and explain differences.
• Document each add-back with invoices, payroll records or other support.
• Separate truly non-recurring items from ones that simply recur irregularly.
• Review customer concentration, contract terms and revenue trends by year.

Build sources and uses early

A sources and uses table shows every dollar coming into the transaction and where it goes: purchase price, working capital, closing costs, fees and reserves on one side; senior debt, seller financing, buyer equity and any other capital on the other.

Building this early surfaces problems while they can still be solved. It forces a realistic view of your equity contribution, the role seller financing can play, and whether the business needs working capital injected at close. Lenders will build their own version; it is better if yours already matches.

Treat structure as a design decision

Price is only one term. Seller notes, earn-outs, working-capital targets, transition consulting agreements and real estate leases all affect how a lender views risk. A seller note that is subordinated and on standby for a period, for example, may be viewed very differently from one that is paid currently.

Discuss structure with your attorney, accountant and financing advisor before the letter of intent is final. Terms that feel minor at the LOI stage can become significant constraints in underwriting.

Make the buyer story concrete

Lenders finance people as much as businesses. Industry experience, management background and a specific plan for the transition period matter, particularly for first-time buyers.

Write down your first-year plan: who stays, what changes, how key customer and supplier relationships will be handled, and what you will not change. A thoughtful plan signals that you understand where the risk in an ownership transition actually lies.

Choose the right lender category

Banks, SBA participating lenders, non-bank cash-flow lenders and asset-based lenders all finance acquisitions, but with different appetites for size, leverage, industry and collateral. Approaching the wrong category wastes time; approaching too many lenders at once can create confusion.

A focused process, with a small number of well-matched lenders receiving a consistent package, usually produces better comparisons and a cleaner path to closing.