Once you have made the decision to purchase a business, your next question probably turns to practicalities- how do you make it happen? A major part of this is likely to involve funding the project, which may in turn involve raising finance to facilitate this.
The method of raising funds for buying a business depends on a number of factors including:
- The nature of the business involved.
- The amount of finance required.
- The financial health of the business and the proposed purchaser
Let’s talk about the most important factor here which is the third point above, the financial health of the business and the proposed purchaser.
Funding for a distressed business purchase vs a healthy business
While a distressed business sale has its attractions due to the ability to add value, it is usually more challenging to raise finance to purchase, as it’s likely that the trading figures won’t be able to display the ability to service any ongoing debt. This can be mitigated by the production of a business plan with detailed costings and cash flow forecast. It can also be attractive to a lender if the proposed new owner has a proven track record in the industry or a history of turning around previously struggling businesses.
Despite this, it is considerably more attractive to a lender for the target business to show a healthy balance sheet and the ability to service any proposed debt. This can be calculated with a simple EBITDA calculation (Earnings before Interest, Taxation, Depreciation and Amortisation) plus any other ‘add ons’ which can be used to service a loan such as directors’drawings or any finance which won’t move with the change of ownership.
Your personal credit rating is still important
It is also important that the proposed owner has a clean credit profile, both personally and with any existing business they run. They should show the ability to service previous debt, a track record in their own business or working life and have no adverse credit history such as County Court Judgements or Finance defaults. If these are present, then obtaining finance will be considerably more challenging.
It is also very possible that a lender will require a form of personal security when considering a lend for a business purchase. This may come in the form of a Personal Guarantee if the business is a Limited Company or even a legal charge over personal assets such as a residential property. For this to be considered, the property will have to have sufficient equity to cover any proposed debt plus some additional equity to offer some comfort to the lender. You’ll usually be required to take independent legal advice on personal guarantees.
What sector the business being purchased is in counts
Lenders all have preferred sectors, so it is considerably easier to raise funding if the target business sits in one of these. Sectors which lenders generally seen as ‘Green’ include Manufacturing, Accountancy Practices and traditional ‘white coat’ businesses such as Doctors and Vets. These are sectors with proven track records and are considered less susceptibleto economic volatility.
Asset finance – the alternative business purchase finance
Depending on the nature of the business, it may be possible to raise finance against the existing assets which are currently held. This funding be raised against ‘hard’ assets such as property, vehicles and machinery which have a tangible value,or against an ongoing debtor book. If the debtor book (funds which the business is owed) is of a good quality, then it’s likely that finance can be raised through a factoring or invoice discounting facility up to the value of approximately 80-90% of the outstanding amount.
Goodwill – you’re paying for it but what is it
As with everything, there are limitations on how much finance can be raised against a certain transaction. Most transactions of this nature will involve a value of the ongoing goodwill of the business which is a notoriously difficult thing to value.
Goodwill is a hugely intangible asset and can be increased massively overnight or even destroyed totally in a split second (a rat seen in a restaurant, Ratner’s etc [Editor: Ratners, bloody hell, well done for keeping it up to date with references! 😂]. Due to this, the parties involved in business transactions are often far apart with their valuations of goodwill and a lender will usually err on the side of caution, aware that the security they have could be erased at any time and leave their lending vulnerable.
What about a deposit when borrowing to buy a business?
A lender is likely to require a deposit from a proposed buyer to show their commitment to a deal. This can range from anywhere from 10% to 50% but more often than not is approximately 25% – 30% which, depending on the numbers involved, can be a substantial amount of money!
While a lender may be willing to ‘take a view’ on an unsecured element of a loan or against using goodwill as security, this will have a limit and if the asking price is unrealistic then your Bank or Broker will likely advise you of this and advise you of a more realistic purchase price.
What information will I need to get finance to buy a business?
If you are considering purchasing an existing business, please make sure you have the following information available before approaching a bank or broker:
- The latest three years of filed trading figures for the business plus any up-to-date management accounts.
- An up-to-date debtor and creditors list
- Full evidence of your personal funds to be used as a deposit and proof of your financial standing (credit report, personal bank statements for example)
- An understanding of how you would secure the debt for a lender which may include the possibility of providing personal security.
- A business plan or at least, an explanation of how you will run the business, changes you may make and the impact this will have on future profitability.
- A detailed understanding of the strengths and weaknesses of your application (there will be both) and how you will mitigate any weaknesses.