What is an Acquisition Loan?
An acquisition loan is a loan that's given to a company to purchase a specific asset or for purposes that are laid out before the loan is granted. Typically, a company can only use an acquisition loan for a short window of time—and only for specific purposes.
How an Acquisition Loan Works
An acquisition loan is applied for, approved, and must be used within the allotted time period for the purpose specified at the time of application. If it is not, the loan is no longer available. Once the loan is paid back per the payment schedule, no more funds are available. In this way, it is unlike a line of credit.
Acquisition loans are sought when a company wants to acquire an asset but doesn't have enough liquid capital to do so. The company may be able to get more favorable terms on an acquisition loan because the assets being purchased have a tangible value, as opposed to capital being used to fund daily operations or release a new product line. The tangible asset can be used as collateral for the loan. If the borrower defaults on the loan, the lender can reclaim the asset that was purchased with the funds and then liquidate the asset to cover the unpaid portion of the loan.
[Important: When a company takes out an acquisition loan, the assets being purchased have a tangible value that can be used as collateral for the loan.]
Acquisition loans can also be used for the purchase of another company. In this instance, the acquiring company has to determine if the target company's assets constitute adequate collateral to cover the loan needed for its purchase. It must also determine whether the combined businesses can generate enough cash to pay off the loan, both the principal and the interest. Sometimes, when an acquisition is particularly large and complicated, an investment bank, law firm, and third-party accountants work together on the structure of the loan to make sure it is properly structured.
Example of an Acquisition Loan
Let's say that XYZ Company manufactures widgets and needs a new widget press. XYZ doesn't have enough capital to make the purchase outright and would like to buy the equipment rather than lease it. It can apply for an acquisition loan from a lender such as a bank for the specific purpose of purchasing the press.