How to finance the purchase of an existing business

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Shaunby Shaun McGowan

Dreaming of owning your own business, but don’t want to go through all the pain and risk of getting a business up and running from scratch?

There’s a way around all of that hassle: buy an existing business.

Buy Business

And I’ve got good news for you:

It may actually cost you less to buy a fully-functioning business than to set up your own. You can expect to pay a higher up-front sum, of course, but you’ll be able to avoid all the costly (and risky) trial-and-error that often comes with setting up a new business.

At the very least (as long as you do your research), you’ll have a clear idea from the outset of how much money you’re going to need – which means less uncertainty than you’ll get with a start-up.

What’s more...

If the business is doing well and making profits, you might be able to leverage its assets or cash flows to help you get the finance you need.

I’ll get to the subject of finance in a minute.

But first…

Before you start looking into financing, you’ll need to thoroughly check out the business you want to buy.

Minimise your risk: make sure your target business is worth buying

Here are some questions you need to ask:

  • Is the owner in a hurry to sell the business within a certain period? If so, they might be willing to accept a lower price if you can meet their timescales.
  • Do they have to sell for specific reasons? If so, what are they? Is the owner ready to retire? Do they need or want the money from the sale? Or could there be underlying issues that could cause you problems later?
  • How much of the company is the seller selling? The whole entity, or just some or all of the trading parts? What about the assets? If they’re keeping any part of it, what impact could that have on the business once it’s yours?
  • Will all the key employees – and their valuable knowledge and expertise – stay with the business? If not, will the business still function?
Key Employees
  • Is the owner hiding any areas of weakness in the business to make it seem more successful and profitable than it really is?

If you decide to continue with negotiations, you’ll be able to explore some of these questions more thoroughly during the due diligence stage. At that point you’ll need to dive deep into the company’s finances and establish whether it’s a solid investment.

Profit and Loss

But before you get that far, there are plenty of steps you can take to find out more about the business for yourself.

Here are some ideas:

Confirm your facts by playing detective

  • If it’s a retail business you’re buying, with a physical store, check out the foot traffic. Drop by on different days and at different times to see how busy it really is.
Observe Business
  • Check out the closest competitors and see how their traffic and profits compare to the business you’re thinking of buying.
  • Get in there and speak to the people at the heart of the business – the customers. Ask them what they like and what they don’t like. After all, without the customers, you simply won’t have a business! Do they use any of the competitors and if so, why? Will they still be willing to support the business if you take over? If they’re unsure, what would it take to secure their loyalty?
  • Do some market research and find out how strong the demand is for the business’s products or services. What are the competitors doing? Are there any strong new competitors or disruptive alternative products coming onto the market? Is there likely to be need for their services in the future? If not, what could you do to keep the business fresh and relevant?
  • Chat to suppliers and find out whether the business pays on time. How does dealing with them compare to their competitors?
  • Talk to some employees if you can, to find out what it’s like working for the company and how receptive they are to the idea of new management.

The four main sources of funding for your business purchase

Before you can put an offer in on your target business, you’ll need to get your funding lined up.

Assuming you don’t have a large nest-egg to spend (if you did, I’m guessing you wouldn’t be reading this article) you have four main options:

Borrow from Bank

Borrow from a bank or alternative lender

This is called debt finance. I’ll take a look at types of business loan in a minute, as there are a few different options you can consider. But, in a nutshell, this means borrowing money to buy your business, then repaying it with interest an agreed time frame.

The biggest advantage of debt finance is that it leaves you in full control of your business.

The downside?

You’ll need to be sure your new business can make enough clear profits to cover your loan repayments.

Borrow from Investor

Find an investor

This is known as equity finance, and it involves finding someone willing to give you capital in exchange for a stake in the business. Obviously, there’s a big plus side to this method – you won’t start your career as a business owner with crippling debt hanging over your head.

If you find the right investor, you’ll also get the benefit of their business knowledge, resources and network of valuable contacts.

The disadvantage – and this could potentially be major if you don’t share the same vision for the business – is that your equity partner will get a say in the decisions you make for your company, as well as a share of the profits.

If you’re wondering where to find an investor, you have a two main options.

Angel Investors

Angel investors

These are generally wealthy people who have experience in particular sectors or industries, and are keen to share their funds and their expertise.

Venture Capitalists

Venture capitalists

These are investment firms that usually have clear guidelines on the type of businesses they’re willing to invest in.

With either type of investor you’ll need to provide a solid business plan and give them a compelling reason to invest in your business, which will probably involve a lot of work!

Borrow from Seller

Ask the seller to finance you

This may sound pretty ‘out there’, and it’s not the most common way to purchase a business, but it’s becoming more and more popular in Australia.

Legal Vision Vendor Finance Screenshot

It’s known as vendor finance, and it can be a great way to own a business sooner if you’re struggling to secure a normal business loan (for example if you’re self-employed, have a low deposit or have a poor credit rating).

Basically, you’ll pay a lump sum down-payment to the vendor, and then pay off the rest of the purchase price in instalments.

Wondering what’s in it for the seller?

They get a quick sale at a higher purchase price, because they will, of course, add interest.

You can definitely expect to pay more for vendor finance than you would for an ordinary business loan. But you could always get a more affordable business loan later, when your finances are in better shape, and pay off the rest of the purchase price in a lump sum.

Borrow from Family

Borrow from friends or family

This may sound appealing, but it can be the worst way to obtain the funds for a business, because there’s so much at stake. Your friend or relative may offer you a loan, ask for a stake in the business, or just give you the money as a gift.

While the gesture is kind, if you find you can’t repay them – or if they want to get involved in running your business and you don’t see eye-to-eye – you could end up destroying the relationship.

If you do decide to take this route, make sure you have a cast-iron legal agreement in place so that you are both clear on your expectations. Treat their loan like any other business finance and keep them updated on how your business is going.

Free family and friends loan agreement template: Download

The right choice will depend on you and your business, of course. As you can imagine, most small business buyers end up seeking some form of debt finance.

Think you might be one of them?

If so, you’ll need to know more about what’s on offer.

Grow the business you want

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Looking for debt finance? These are your options

Secured Business

Secured business loan

I’ve put this first on the list because it’s probably the lowest-cost option, but it can also be very risky for you. It involves using property as security for the loan you need to buy your business.

If the business happens to own property then you may be able to offer that as security, but sadly most small businesses rent their offices, storefronts and warehouses – so they don’t have a property to use as collateral.

That means you’re probably looking at using the equity on your own home as security for your business purchase. It can be a relatively easy way to secure a loan or increase your borrowing capacity, but it means your house is on the line if your business fails. And I know you don’t want to lose your home as well as your livelihood.

It’s definitely not a decision you should make lightly, so be sure to discuss your options with your financial advisor.

Peer to Peer

Peer to peer borrowing

There’s a growing market in Australia of keen private investors willing to cut out the middle man and make a direct investment in small business. There’s a number of platforms that match investors with entrepreneurs, with both sides getting a better deal because there’s no bank cut to pay. Here’s a good overview of peer to peer funding and different platforms you can look at.

Moneyplace Peer to Peer Business Loan Screenshot Unsecured Business

Unsecured Business Loan

If you don’t have property you can (or want to) use as collateral, you could turn to an unsecured loan to help you get the funds to buy your business.

Unsecured business loans tend to be a short-term financing option, so you may only be able to borrow a portion of the purchase price for a year or two. But if you already have some capital, it could be enough to bump your funds to what you need to acquire the business, or to boost your working capital during the takeover period.

Equipment Loan

Loan secured on machinery and equipment

If you’re buying a business that owns valuable vehicles, equipment or machinery you may be able to borrow against them to get the capital for your purchase.

The downside is that if you want to sell or upgrade that equipment before you’ve paid off your loan, you’ll have to get permission from the lender.

Many ordinary lenders will offer loans secured in this way, or you could turn to a specialised equipment lender.

SMH Purchase Business Finance Screenshot LEND Equipment Finance Screenshot Factoring Invoice

Invoice Financing

If the business you’re looking at offers payment terms to its customers, it may well have a lot of outstanding invoices (receivables) which you may be able to use to raise finance.

This option, known as invoice finance or factoring, isn’t actually debt finance, because you’re selling the amounts owed to you by customers to a third party rather than borrowing against them.

Like an unsecured business loan, factoring is a short-term financing option that is better suited to helping you keep the cash flowing during the first few months of operations, rather than covering the cost of buying the business.

Crowdfunding Loan

Crowdfunding

While this may not be the obvious choice for buying a business, people are turning to crowdfunding for all sorts of reasons these days – including raising money to buy a business. Kickstarter is probably the most well-known crowdfunding site, although it does have some strict rules on the types of project you can list. GoFundMe is another popular site, and less selective about what you can raise funds for.

Kickstarter Screenshot GoFundMe Screenshot

The good news about GoFundMe is that you don’t have to reach your entire projected goal to receive what you raise (less their fees, of course) – unlike Kickstarter, which is ‘all or nothing’, and gives back all the money to the ‘crowd’ if you don’t reach your goal.

There are plenty of other crowdfunding options out there, too, so do some research if you want to give this a go. Be prepared to offer incentives (like free product samples or membership benefits) to entice people to donate!

Conclusion

Starting your own business can be taxing in many ways. You’ll have to do endless amounts of research and have a good understanding how the numbers work to make sure it’s even worth it – and it’s always a risk trying to build a customer base from scratch.

Funding a start-up can be especially hard, since very few lenders, even in the alternative market, are willing to finance an untested business idea.

Buying an existing business can still be a lot of work, of course, but you’ll go into it with a big advantage – not least when it comes to raising funds.

Sure, you’ll have to put in the time and effort to verify that the business is sound. But once you’ve done your due diligence, you’ll have the financial and sales information you need to present to potential lenders or investors, to show that you’ll be able to pay them back.

There are many different ways to raise funds to buy your business and you may have to explore a few of them before you raise the funds you need. But don’t give up! With time and effort, you could soon be the proud owner of your exciting new business.

Have I missed any great ways to fund a business purchase? If so, tell me in the comments below! I’d love to hear your ideas!

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