How to Finance a Gas Station Business Acquisition

Gas stations are very common, but they are also one of the toughest businesses to operate. The fuel market is competitive and profits can be volatile. Consequently, financing an existing gas station acquisition can be both difficult and complex. This article provides an overview of gas station finance. We cover the following subjects:

  1. Financing options
  2. What do lenders look for in a transaction?
  3. Potential hurdles and roadblocks
  4. Most common structure

How are gas station acquisitions financed?

The type of financing used for an acquisition varies and depends on the value of the gas station. In this article we focus on transactions that are in the $700,000 – $5 million range. These represent the majority of the small business market for gas stations.

1. Buyer’s own assets

The easiest, but also the least common, way to pay for a gas station acquisition is for the buyer to pay the full price using their own funds. This removes all the hurdles that come with external financing. Realistically, few buyers can afford to buy a business outright with their own money.

This does not mean that you will not use some of your money for the acquisition. You should still expect to use some of your funds in the transaction. Most lenders expect buyers to contribute around 10% of the acquisition value. This 10% is often referred to as an “equity injection” or down payment. The actual percentage varies by lender and transaction configuration.

Note: We are not aware of any lender that does not require an equity injection and offers 100% financing.

2. Seller financing

Sellers often offer financing to help buyers acquire their companies. Keep in mind that they do this because they have to – not because they want to. Sellers would prefer not to offer financing. They’d rather get the whole payment immediately.

Sellers offer financing because it serves as an incentive to attract buyers. Buyers, on the other hand, like seller financing because it usually offers competitive terms. It is also easier to get than conventional lender financing. Seller financing has one more very important benefit. It ties some of the seller’s payments to the performance of the business for the term of the loan

3. Lender financing

Most small and midsized gas station acquisitions use some form of lender financing to cover the bulk of the cost. Buyers can use one of two options – conventional loans or Small Business Administration (SBA) backed loans. The majority of small and midsize transactions in this market segment use a SBA-backed loan however.

SBA backed loans are easier to get than conventional loans. This is because the SBA provides incentives to lenders to make loans available to the public. These SBA incentives provide an important advantage over conventional bank financing. While the documentation requirements are similar between SBA and non-SBA loans, the SBA has easier qualification requirements. For more more information, read “How to get a loan to buy a business.”

What do lenders look for in a gas station acquisition?

Understanding your lender and where they come from is important for the success of the acquisition. It allows you to craft your offer accordingly which increases your chances of accomplishing your objective.

In this section we cover some details of what lenders look for in a gas station acquisition. Keep in mind that every lender is different and has their own requirements.

1. Can the gas station afford the loans?

Lenders want to finance gas stations that are in good financial shape. They want the business to be able to pay back the loans out of its own revenues. If the gas station is unable to pay for the financing out its revenues, it won’t qualify for most types of financing. Lenders examine the company’s financial statements to determine there are enough resources to pay for financing, sustain the business, and pay the owners salary.

2. Buyer’s industry experience

Lenders prefer to work with buyers that have direct experience in the industry. Buyers should have direct experience managing a gas station similar to the one the are buying.

This creates a dilemma for buyers that want to get into the industry but don’t have the right experience. Fortunately, there is a way around this issue. Most lenders will work with you if you can hire a manager from the existing business and retain them for a couple of years.

3. Buyers assets and equity injection

All business acquisition loans – SBA backed or not – require that the buyer put some equity into the transaction. They don’t make exceptions to this rule. Lenders expect buyers to inject about 10% of the business value into the transaction. The equity injection cannot be borrowed and cannot come from the seller. It must come form the buyer and their partners.

4. Buyers credit score

Lenders look at your credit score, among many other items, as part of their due diligence. SBA-backed programs require a minimum credit score of 650 – 680. Non SBA programs usually have higher requirements.

Some buyers are perplexed when they find out that their credit score plays a role in the transaction. After all, they want a business loan. Why does they personal score matter? Lenders ask for this information because they want to determine if the buyer will manage the company in a financially responsible way. Credit score can serve as a proxy indicator for this, albeit imperfectly.

5. Transaction size

Most lenders have a preferred transaction size and will not approve transactions that are outside that range. In our case, we prefer transactions that are between $700,000 – $5,000,000 in value. We can consider larger transactions on a case by case basis.

6. Is a real estate provision included?

Gas stations are location sensitive businesses. They need a good location to be successful. Lenders understand this issue and will seldom finance transactions that don’t include a provision for the real estate as well. You must either have a lease that allows you to lease the space for the term of the loan or you must buy the real estate. Otherwise, the gas station could risk loosing the location, and consequently their revenues.

7. Convenience stores or other additional revenues sources

Selling fuel – gasoline or diesel – is a very low margin business that is subject to market fluctuations. Lenders consider gas stations that solely rely on fuel sales to be risky. They prefer gas stations that have additional revenue centers. Revenue centers can include convenience stores, car washes, or automotive maintenance shops.

8. Environmental issues

Environmental issues are one of the biggest risks in gas stations acquisitions. Surface or subsurface contamination can occur when gasoline or petroleum products from storage tank systems, hydraulic lifts, car washes, or service bays is released. This kind of problem can be expensive to deal with. Note that the contamination may have occurred recently or in the past. Either way, it could become your problem.

Environmental concerns are one of the reasons why lenders scrutinize gas station transactions carefully. An environmental problem can easily derail an acquisition. Lenders review every environmental aspect of the gas station. However, they pay close attention to the fuel tanks, since they are often a source of problems. They generally consider these items during their due diligence:

  • Gas station’s age
  • Location or tank
  • Adjacent properties
  • Tank materials (fiberglass vs. metal)
  • Environmental test results

In the area of environmental risk, your interests and those of the lender are aligned. You probably don’t want to buy a gas station with environmental problems. And your lender doesn’t want finance such a transaction.

9. Good financial records

Lenders don’t feel comfortable financing acquisitions were the gas station cannot justify its revenues and expenses. Neither should you, by the way. You should expect the seller to provide accurate financial statements before or during the due diligence process. Gas stations get a large portion of their revenues from cash sales. Some smaller operators are not as diligent as they should be recording these sales. This issues reflect on the financial statements and can derail a transaction.

10. Reasonable valuation

Lenders want to ensure that they finance only transactions that have a reasonable valuation. They don’t want to finance an overvalued acquisition. As a buyer, neither do you. Most lenders use industry rules of thumb to establish if the valuation is reasonable. Keep in mind that the lender’s determination does not replace a professional appraisal.

Rules of thumb vary based on whether the gas station is full service or self-service. They are also different if the gas station has a convenience store, minimart, or other revenue centers. Here are some assumptions for gas stations that focus only in selling fuel:

  • 2.5 – 3 times SDE, plus inventory
  • 2.5 – 3 times EBIT
  • 2.5 – 3.5 EBITDA (business only)

Stations with a mini-mart or a convenience store can be valued using these rules:

  • 80% annual sales with real estate (plus inventory)
  • 20% – 25% sales plus inventory
  • 3 to 5 times EBIT
  • 2.5 – 3.75 EBITDA (business only)

Definitions:

  • SDE means Sellers Discretionary Expenses
  • EBIT means Earnings Before Interest and Taxes
  • EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortization

11. Active business owner

Some buyers have the objective of purchasing a gas stating and running it as an absentee owner. Note that most lenders are unwilling to support absentee-owner transactions. Lenders prefer to work with owners that want to work in the business full time.

12. Lender area of expertise

You could have the most profitable gas station acquisition transaction possible. However, if you present it to a lender that is not comfortable with gas station acquisitions, it will be declined. Few borrowers realize that lenders have areas of expertise that they focus on. Lenders have industries that they like, and industries that they dislike. It’s important that you work with a lender that is comfortable with gas station acquisitions.  Otherwise, you could run into problems. Fortunately, there is a simple way to handle this issue. Ask your lender directly.

Problems that kill transactions

This section covers five of the most common problems that will kill a transaction. Keep these in mind as you prepare your transaction:

1. Insufficient buyer’s equity injection

Lenders require that buyers invest some of their own funds in the acquisition. The requirement varies by transaction but it’s usually around 10% of the acquisition value. Unfortunately, transactions were buyers are unable to meet this requirement won’t get financing. Learn more about sources for the equity injection.

Note: Unfortunately, lenders don’t make exceptions to this policy.

2. Real estate provision issues

Transactions must include a real estate provision that meets the lenders requirements. Without the option to secure the location, the transaction will likely fall through. Keep in mind that some brands may have provisions that prevents other brands from operation in that space.

3. Environmental issues

Unless disclosed by the seller, any existing issues will come up during a Phase I Environmental Site assessment or similar examination. This examination is done during the due diligence phase. Finding a serious environmental problem will likely kill the transactions chances of success.

4. Minimal inside sales

Fuel sales are a low margin business that can have volatility. They depend on volume. This makes them risky for some lenders. Consequently, most lenders prefer working on acquisitions that have diversified revenue sources. These can include revenues that come from an onsite convenience store, mini-mart, car wash or auto maintenance shop.

5. Questionable financial statements

Many transaction fail due diligence because the gas station cannot justify it’s financial statements. This can be a problem for smaller stations that don’t have good cash management and accounting practices. In many cases, there is little you can do about this.

How are most transactions structured?

The main objective for many entrepreneurs is to buy the largest gas station they can afford. Consequently, they use external financing and try to finance as much of the transaction as they can. This type of transaction is commonly referred to as a leveraged buyout (LBO). Leverage buyouts have the advantage of enabling you to buy a large business while limiting your own investment. In the case of a small business LBO, you usually have to invest only 10% of the transaction with your own funds.

Leveraged buyouts are designed to maximize your returns if things go well.  This is why investors like them. There is one important disadvantage though. If things don’t go well, an LBO can also wipe out your equity. This is something you must balance carefully. Transactions to buy a gas station mostly use a combination of these three sources:

1. Your own funds – 10% equity injection

Buyers contribute a minimum of 10% of the acquisition price of the transaction and inject it into the business. Some transactions may require a higher capital injection.

2. Seller financing

Seller financing is also quite common in small business acquisitions. The amount of the loan and the terms vary, though. Loans for 5% – 20% of the business value are common. However, there are some transactions where the seller doesn’t offer financing.

3. SBA-backed financing

What ever amount that is not financed by the seller or covered by the equity injection is financed using a lender. The most common product is an SBA backed loan.

Looking to buy a gas station?

The first step to work with us is to submit this form. Once we review it, one of our associates will contact you to discuss the specific details of your acquisition.