Sources and uses in a small business acquisition
By Mainshares
Aug 8, 2023
In Buying a Business
Often when entrepreneurs first look at businesses listed for sale on BizBuySell, they assume they need to pay the purchase price with all cash. In reality, business acquisitions are more complicated than that.
What goes into sources and uses in a business acquisition?
Entrepreneurs will normally have more financing “sources” than just cash to purchase a business. They may use a promissory note from the selling business owner (a “seller note” or “seller financing”), an SBA 7(a) term loan from an SBA lender, cash as an equity injection (or “down payment”), and investor capital.
Additionally, the entrepreneur will have more “uses” than just the business purchase price. They may want to finance transaction expenses, such as legal bills, regulatory fees and quality of earnings reports. If they use an SBA loan, they may incur loan packaging fees from the lender as well as the SBA Guaranty Fee. If they buy a business that does not come with cash or accounts receivable to help cover expenses, they may need to include some money to serve as working capital.
Thus, the “sources” and “uses” for a business acquisition paint a full picture of the transaction. A sources and uses analysis will show where any funds used in an acquisition will come from and what the capital will be used for. The total sources and total uses should equal one another.
An example business acquisition
The below sources and uses analysis shows a prospective acquisition of a business for $1.8M. As you can see, the total uses of the acquisition total $1.96M. Included in the uses is $100K of working capital to be injected into the business’s bank account on closing. Additionally, $25K of transaction expenses are included (e.g., legal, accounting help, administrative setup costs).
The SBA Guaranty Fee is a formula that calculates the SBA’s fee based on the size of the loan in the sources section. Lastly, this assumes that the entrepreneur pays a private placement fee for raising equity from investors (a flat 5% on equity raised).
On the uses side of the table, it’s typical to start with the amount of cash an entrepreneur can contribute to the deal as well as the percentage that will be financed by an SBA loan. In this case, 80% of the total uses (or, “project costs”) will be financed by an SBA loan, and the entrepreneur has $100,000 available to invest at close. Thus, the investors will put in the remaining $488K so that total sources equal total uses.
Tracking sources and uses for your business acquisition
When going through a self-funded search to find a business, it’s important to keep a budget for transaction expenses and to keep monitoring how much you’re able to invest as a down payment. This will help you triangulate what size business you can afford as well as how you’ll need to structure your sources.
As you can imagine, the type of business you’re considering buying matters, too. Some will need a lot of working capital to operate. Others may require immediate capital investments (e.g., new lifts in an automotive shop).
Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.
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