Many buyers discover the hard way that a term sheet is not the same as a fully funded purchase. The bank approves a loan, the numbers look encouraging at first glance, then the credit committee caps leverage or advance rates and the structure stops short of the full price. You have a willing seller, a realistic business, an initial financing offer, and still a hole between what the bank will lend and what you can inject in equity.
That gap does not automatically kill the transaction. It simply means the capital stack is incomplete. The question is whether the business can carry a layered structure that includes senior debt, buyer equity, and a gap piece such as seller financing, mezzanine debt, preferred equity, or a mix of these. The difference between a closed deal and a failed raise is usually discipline in how that stack is designed, negotiated, and presented.
A typical scenario looks like this. You sign an LOI to buy a company for 10 million. The target generates 2 million of stable EBITDA. You approach a bank or SBA lender and receive terms for 6 million of senior debt. You and your partners can inject 2 million of equity. That leaves 2 million unfunded.
The shortfall is the funding gap. It is not a sign that the acquisition is unrealistic. It simply reflects normal bank policy around leverage multiples, collateral coverage, and risk appetite. Senior lenders want to see a clear cushion of equity and, in many cases, a layer of subordinated capital that absorbs volatility before the bank is exposed.
Once you accept that the bank seldom finances one hundred percent of the purchase price, the real work starts. You need to define what part of the price can be shifted into seller financing, contingent consideration, mezzanine debt, or preferred equity so that the acquisition still clears both the seller's expectations and the lender's risk standards.
The capital stack for a business acquisition is simply the ordered list of who puts in money and who gets paid back first. It is easier to design sensible structures when you think in layers rather than products.
| Layer | Who it is | What they expect | Typical position |
|---|---|---|---|
| Senior debt | Banks, SBA lenders, senior credit funds | Security, covenants, scheduled amortisation, moderate coupon | First claim on assets and cash flows |
| Gap capital | Sellers, mezzanine lenders, preferred equity investors | Higher return for taking subordinated risk | Paid after senior but before common equity |
| Common equity | Buyer, management, co investors | Residual upside, full downside | Last in the queue on distributions and exit proceeds |
The senior lender cares that there is enough true equity and subordinated capital beneath them. The seller cares about total value and certainty of closing. The buyer cares about control, cash flow coverage, and eventual return on invested equity. Gap financing is simply the middle layer that adjusts those trade offs until the deal becomes acceptable to all three sides.
There is no single product called a gap loan. The shortfall is filled by standard instruments that sit beneath senior debt and above common equity. The combination depends on the size of the gap, the quality of cash flow, and how flexible the seller is.
A seller note is a deferred portion of the purchase price. The buyer pays interest and principal over an agreed schedule. The note is usually subordinated to the bank and may have payment standstill provisions if covenants are breached on the senior facility.
The risk is that poorly drafted terms can create tension between buyer and seller after closing. Repayment schedule, security, and remedies need careful drafting so that the note does not choke cash flow.
An earn out shifts part of the price into future years, payable only if the business hits agreed financial targets. The gap is not funded at closing but is effectively bridged by lowering the initial cash consideration.
Earn outs become toxic if the metrics are vague or easily manipulated. Revenue, gross profit, or EBITDA definitions need to be precise so that both sides know what must be achieved for payments to trigger.
Mezzanine capital is debt that sits behind the bank in right of payment and often comes with a higher coupon and sometimes warrants or success based fees. It works when the target has strong and predictable cash flow that can support extra fixed charges.
Mezzanine providers will run their own credit work. They are not a last resort for broken deals. If the senior facility already pushes leverage too far, serious mezzanine funds step away rather than stack risk.
Preferred equity sits above common equity in distributions and at exit but below all debt. Minority co investors or family offices can fill a gap by subscribing to structured equity that carries a negotiated coupon and preferences.
The trade off is dilution and governance. Preferred investors will want board rights, reporting, and often consent rights on major decisions. Buyers who want complete control need to weigh that carefully.
Gap financing is a tool for sound acquisitions that fall slightly short on simple bank plus equity math. It is not a way to force through marginal deals that only work on paper. There are clear signs for both cases.
In those situations gap capital is not solving a simple shortfall. It is masking a larger problem in business quality, price, or sponsor strength. Walking away is often cheaper than forcing a structure that will strain cash flow and relationships from day one.
The way you frame the gap often decides how cooperative banks and sellers will be. A buyer who arrives with a clear capital map looks very different from someone who simply asks for more leverage or a discount.
What does not work is asking each party to fix the entire problem. Banks will not suddenly double their limits. Sellers will not usually cut price enough to remove all shortfalls. Mezzanine and preferred investors will not rescue thin equity contributions on weak targets.
Many business acquisition financings fail for avoidable reasons. The underlying businesses are often acceptable, but the process, structure, or messaging is not.
Professional acquirers treat financing like another core workstream, with owners, timelines, and version control. They are realistic about what each layer of the capital stack can and cannot do and they avoid boxing themselves into promises that the numbers will not support.
Not every acquisition needs advisory input. However, once you move into larger transactions or more complex structures, an independent view on the capital stack can save time and prevent expensive mistakes.
A specialist can help you:
The focus is not on chasing unrealistic promises. It is on aligning price, structure, and risk so that the deal has a genuine chance of closing with counterparties who know this market.
If you have a signed LOI or purchase agreement and a bank that will not cover the full price, we can review the transaction, design a practical capital stack, and prepare a financing pack that lenders and investors can work with.
Share your LOI, last three years of financials, and any existing term sheets. We will respond with a view on what the business can support and where gap financing makes sense, if at all.
Request Acquisition Financing ReviewDisclaimer: This page is for general information only and does not constitute legal, tax, investment, financial, or regulatory advice. References to banks, mezzanine lenders, seller financing, preferred equity, or gap financing structures are descriptive and do not represent a commitment by Financely to arrange or provide funding. Financely is not a bank, lender, broker dealer, or investment adviser and does not accept client deposits or manage client money. Any advisory engagement is subject to eligibility checks, KYC and AML procedures, sanctions screening, and the terms of a formal engagement letter. All financing outcomes depend on third party credit decisions and market conditions.
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