Summary: Acquiring an existing freight carrier can be challenging for new buyers looking to buy a small business. This article discusses how entrepreneurs can finance a trucking company acquisition. It provides you with the basic foundation of knowledge to understand your options and develop the best strategy. We cover:

1. Advantages of carrier companies
2. How are trucking company acquisitions financed?
3. What do lenders look for in a transaction?
4. Common red flags
5. Transaction structure
6. Financing operations
7. How much money do you need?

1. Advantages of a trucking company

Trucking companies have some advantages over other types of businesses. They are a backbone of transportation, are considered an essential business, and are not susceptible to overseas competition. Trucking companies, especially those in some specialized cargo (e.g., refrigerated produce), also have some resistance to recessions. This makes purchasing an existing trucking company an attractive option for executives looking to grow by merging with another company or for entrepreneurs looking buy an existing business.

2. How are trucking carrier acquisitions financed?

This article focuses on acquisitions under $5,000,000, which are usually limited to a few financing options. These transactions are typically financed using some, or all, of the following sources:

a) Buyer's equity injection

Every acquisition requires the buyer to contribute equity to the transaction. The equity injection contribution must come from the buyer since it cannot be financed. This requirement can create a dilemma for buyers because an acquisition usually depletes their savings and investments.

The equity injection must cover a minimum of 10% of the entire acquisition cost. In some cases, this amount can be reduced to 5%. To qualify for this reduction, the seller must also offer financing and agree to a standstill. Few sellers agree to these terms because a standstill prevents them from collecting their loan until the primary lender is paid.

b) Seller financing

Most acquisitions that we handle have a seller financing component. Sellers prefer to avoid offering financing, since they want to be paid quickly. However, buyers usually ask for seller financing because it shows that the seller is confident in their company. In our experience, transactions often have a token amount of 5% seller financing. However, seller financing can approach 15%.

c) SBA-backed financing

Buyers who want to acquire a company under $5,000,000 typically use Small Business Administration (SBA)-backed financing. The SBA helps finance small acquisitions through its loan programs. Note that the SBA is not a direct lender. Instead, it partners with lenders that get a special guaranty if they finance smaller transactions.

Getting business acquisition loans from the SBA is usually easier than getting conventional bank financing. The SBA's loan requirements are flexible and aimed at helping small business owners.

d) Banks

Some banks provide acquisition loans to select clients. This option can be a resource if an acquisition does not qualify for SBA-backed financing. Conventional loans don't have protection guarantees from the SBA. Consequently, they have stricter qualification requirements for the buyers. For conventional loans, buyers usually need to have sufficient personal collateral and excellent credit.

e) Family offices

Family offices are an excellent resource for small business acquisitions. They are flexible about the transaction size and the type of opportunity. For example, a family office may consider financing the purchase of a freight carrier in financial distress that needs to be turned around. Conventional lenders usually shy away from these complex transactions.

3. What do lenders look for in a transaction?

Buyers need to understand how lenders underwrite an acquisition. This knowledge allows buyers to anticipate potential challenges and structure the transaction effectively. Each financing company has in-house proprietary criteria. However, most companies focus their underwriting efforts on evaluating the following six areas:

a) Can the freight carrier cover the financing costs?

Lenders examine the financial health of the target carrier to determine if they can afford to pay the financing costs and remain profitable. Lenders will not finance an acquisition in which the target freight carrier cannot pay for financing out of proceeds.

b) Can the buyer afford the equity injection?

Buyers must be able to cover the equity injection using their investments, savings, or a partner. Lenders will not finance an acquisition if the buyer cannot afford it.

c) Can the buyer and seller provide financial information?

Lenders evaluate the financial situation of the target trucking company and the buyer during their due diligence. Both the target business and buyer must be able to provide three years' worth of accurate financial and tax records.

d) Is the valuation reasonable?

A lender will not finance an overvalued acquisition regardless of its "future potential." The risk of a transaction losing value is too high. Instead, they finance transactions whose valuation falls within a reasonable market range. Note that valuations change based on current and expected market conditions. Here are some sample valuation "rules of thumb" for long-distance freight trucking companies:

• 2 to 3 x SDE + market value of assets
• 5 x EBIT
• 2 to 3 x EBITDA

SDE = Seller's Discretionary Earnings
EBIT = Earnings Before Interest and Taxes
EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization

e) Is the equipment in good shape?

Lenders evaluate the carrier's power units and trailers to ensure that they are in reasonable shape and can continue operations. Acquiring a trucking carrier where most trucks and trailers are approaching their end-of-life is challenging for the buyers.

f) Does the buyer have relevant experience?

Lenders want to ensure that the buyer has relevant experience in transportation or logistics. Ideally, the buyer will have working experience in a trucking company or freight brokerage.

4. Common red flags

Recognizing potential problems with a transaction early on can help you improve your chances of executing a successful acquisition. This section covers five of the most common red flags associated with trucking company acquisitions.

a) Seller unable to provide financial information

The most common problem we see in acquisitions is sellers who cannot provide accurate financial and tax reports from the business. Without these records, the transaction won't be financed. Buyers should discuss this issue with sellers early on so that the seller has time to get their records in order.

b) Shipper concentration

Buyers and lenders often seek carriers with a well-diversified direct shipper base. Lenders are cautious when a trucking company gets most of its revenue from one or two shippers. Revenue concentration is risky because losing a single shipper would seriously impact the business.

c) No or minimal direct shipper contracts

Buyers are usually cautious when a carrier has few direct shipping contracts. Relying solely on freight brokers, or worse, load boards, is considered risky. Furthermore, it lowers the carrier's profit margins substantially.

d) Unreasonable SDE and add backs

The Sellers Discretionary Earnings (SDE) is commonly used as an initial valuation tool. It shows the expected earnings buyers can expect from the business. Sellers want to present their highest possible SDE since it increases the sales value of the carrier, which is in their best interest.

An add back is an adjustment that increases the SDE. It adds back the value of certain expenses that the new owner does not need to be responsible for. Examples may include certain renovations, memberships, etc. Lenders, buyers, and sellers negotiate add backs and SDE regularly. Unreasonably high SDE or add backs can derail a transaction.

e) Incompatible equipment / driver base

Carriers looking to merge with another company must also consider if the equipment and driver base is compatible with their current company. Any major problem in this area will likely derail the transaction.

5. Transaction structure

Most transactions we work with involve buyers using their savings and investments in the transaction. These buyers have limited resources and need to limit their equity injection to 10%. The remaining 90% is financed through the sellers and an SBA-backed loan.

We should note that transactions that use 90% financing qualify as leveraged buyouts (LBO). In our experience, most transactions under $5,000,000 qualify as small business LBOs. This structure has both advantages and risks that buyers should consider.

a) Equity injection

Transactions usually have an equity injection component of 10%. Few transactions have a 5% equity injection – and only after the seller agrees to provide a minimum of 5% of seller financing and take a standstill.

b) Seller financing

The seller financing component usually has a token amount of 5% to 10%. Some transactions can have as much as 15% seller financing, though they are not common.

c) SBA-backed financing

In most cases, the bulk of the transaction is financed using an SBA-backed loan. This component covers the amount that was not contributed by the equity injection or seller financing.

6. Financing ongoing operations

Most buyers tend to focus their effort on financing the acquisition. However, they seldom consider how to finance the operations after purchasing the business. Freight carriers are cash flow intensive businesses. You constantly need funds to pay for drivers, fuel, and repairs. However, most shippers pay their invoices in net-30 to net-60 days. This situation often creates a cash flow problem, which is common in the transportation industry.

This cash flow problem can be solved with a financing solution such as freight bill factoring. However, buyers have to get this type of financing at the same time they get the acquisition financing. This timing allows the lenders to structure the acquisition accordingly and work out the proper inter-creditor agreement.

Getting additional financing shortly after an acquisition is nearly impossible. If you need working capital financing, plan to obtain it while you finance the acquisition.

Note: The link to freight bill factoring takes you to a sister website.

7. How much money do you need?

Most buyers think that the equity injection percentage is based on the trucking company's sale price. This mistake can lead to problems as the transaction progresses. The equity injection percentage is based on the total project cost. The total project cost includes:

• Cost of the business
• CapEx additions
• Working capital additions
• Closing costs

CapEx refers to capital expenditure additions. These items include facility and equipment upgrades and purchases. Working capital refers to any additional loan amount to operate the business after the purchase. Most buyers contribute only a 10% to 15% equity injection. Consequently, the amount of money you need to buy a trucking carrier is about 10% to 15% of the total project cost, as outlined above.

Want to finance a business acquisition?

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.

 

Editor's note:

This information should not be considered legal or financial advice. Given the complexity of business acquisitions, this document is not guaranteed to be 100% accurate or cover every potential option. However, we make every effort to provide you with the best information. If you have comments, suggestions, or improvements, contact us via LinkedIn.