Investing offers a wide range of possibilities. From financial markets to real estate to privately held businesses. The latter, in turn, offers a variety of options to suit any budget. From the simplest and least costly, such as debt, to more sophisticated options that require greater wealth, such as private equity funds. Investments in SMEs can deliver double-digit returns or more. The latest SpainCap and EY report on the returns of private equity funds in Spain highlights that, over the last 15 years, the annualized internal rate of return (IRR) stood at 11.3% in 2022, four times that of the IBEX 35 and more than 70% higher than the EuroStoxx 600.
However, these strong figures come with a clear challenge for investors: getting financing to buy an SME.
Perhaps the biggest problem isn't finding a good investment opportunity, but securing the liquidity needed to make the investment.
Steps to get financing to buy an SME
1. Company valuation
The first step is the company valuation, which lets you analyze the potential return and the payback period of the investment and weigh the feasibility of the deal, both in terms of performance and your ability to finance it.
2. Liquidity
Now that you know what the company is worth and the return it can generate, it's time to answer the question of how much liquidity you need. How much money do you need to take on the deal? Do you have your own funds? Do you need outside funding? (Below, we outline the profiles of possible financing sources.)
3. Business plan
If you need outside financing, you'll have to present a detailed business plan that justifies the feasibility of the deal. Include:
- Acquisition objectives.
- Financial projections and repayment plan.
- Management and growth strategy.
- Risk analysis and solutions.
A good business plan improves your credibility and increases your chances of getting financing to buy a company.
4. Evaluate the available financing sources
There are several options for financing the purchase of a company, from traditional bank lending to alternative financing. You can go “all in” on one of them, but it's more common to combine them. The most common are:
Bank financing: banks offer loans specifically for acquisitions. However, for large deals, this may not be the best option, or at least not one to go “all in” on. Banks will generally ask for certain guarantees, even personal ones, such as your own home. This means there may be certain risks to weigh. Look at how much money they can lend you without taking on personal risk, the repayment term they offer, and the interest rates. If the loan is manageable and can be repaid from the profits the company generates, it's an option worth considering, even if only to finance part of the deal.
Partners: another traditional route is to pool capital among several investors with a profile like yours, which can be useful for reducing dependence on third-party institutions. There's also the possibility of a strategic partner, a competitor interested in joining the deal to grow and, in doing so, eliminate rivals.
Private investors (private equity, business angels, venture capital): these investors provide funds in exchange for a stake in the company or future profits. They can invest directly or by raising an investment fund. That said, this process can be more complex because of regulation and the role the fund wants to play in the deal. But they're undoubtedly the ones who can provide the most financial muscle, as well as more assurance when seeking financing from other sources. This type of financing aims for high returns, but beyond that, these investors also have a strong strategic advisory team that can be a great ally in helping the SME grow much further.
SPV (special purpose vehicle): special purpose vehicles are a less well-known option. They're companies created for a specific purpose, such as buying another SME. What makes them interesting is that they operate independently and are kept separate from other businesses. For example, if one company wants to buy another, it can do so through an SPV to keep separate accounts for the two. That way, if the investment goes wrong, it doesn't affect the core business. It's a way to approach an M&A process while reducing financial risk, securing financing specific to that project, or starting a new venture with other partners.
