What Is an Acquisition Loan?

An acquisition loan is a loan that's given to a company to purchase a specific asset, to acquire another business, or for other reasons 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 the agreed upon purpose.

Key Takeaways

  • An acquisition loan is a loan that allows a company to purchase an asset or to acquire another company.
  • There are set rules on what an acquisition loan can be used for as well as the time in which it can be used.
  • There are many different types of acquisition loans, such as startup loans, SBA loans, equipment financing, and business expansion loans.

How an Acquisition Loan Works

An acquisition loan is sought out when a company wants to acquire an asset or company 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 to 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.

When an acquisition loan is applied for and approved, it 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 different from a line of credit.

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 accountant work together on the structure of the loan to make sure it is properly structured.

Types of Acquisition Loans

As there are many different types of acquisitions that require different needs, there can be many different types of acquisition loans. The following are some of the more common acquisition loans available to businesses and individuals.

Startup Loan

If you don't have a business currently but are looking to purchase a business, you can apply for a startup loan. Startup loans are offered by regular banks, the Small Business Administration (SBA), and other lenders. Before being approved for a startup loan, you will have to show to the lender that you have the skills and ability to operate a business, and you may be asked to make a down payment on the business.

SBA Loan

SBA loans are supported by the SBA, up to 85% of the loan, and are, therefore, considered less risky if a borrower defaults. This allows a borrower to receive better interest rates and payment windows for the loan. The SBA has an extensive framework in place to help borrowers find the right lender as well as any other assistance needed in the process.

Business Expansion Loan

A business expansion loan is one that is provided to individuals that currently own and operate a business. This allows the lender to see first hand how risky the prospect of lending might be. It also allows the lender to gauge the ability of the borrower to run a business profitably and to pay back the loan. Business expansion loans often require that a business has been in operation for a certain amount of time before the lender is willing to extend financing.

Equipment Financing

Equipment financing is not a type of loan but financing with certain stipulations put in place for the purpose of purchasing equipment for a business. For example, in equipment financing, the asset being purchased is the collateral for the loan. This oftentimes removes the need for additional collateral or a thorough credit check.