businessman funding to buy a business

Funding to Buy a Business: Exploring Your Options

It’s possible to buy pretty much any type of small business you can think of. The key to making the right choice is to think about what you know (or can learn), what your track record is, and what your goals are, both financial and personal.

Say you are interested in mergers and acquisitions, and you want to build a group of companies and sell them for a profit; buying businesses that are asset-rich, such as transport companies, for example, might help you when it comes to raising funds for growth.

Say you want regular income; something that has customers that make monthly payments, like software as a service or digital marketing, might fit the bill. Be aware with this type of business that they generally have no assets to borrow against, but you might be able to leverage cash flow.

Businesses that attract a loyal customer base, such as hairdressers, dentists or opticians, can be good options and might have hard assets plus income to work with.

What you buy and how you fund it is largely driven by what you want to achieve, so be clear about why you are buying a business before you take the plunge. And no matter how good it seems to be, always do your due diligence before you commit to anything.

Debt financing options

There is a range of debt financing options available to you when looking to make a business purchase. Eligibility is likely to be impacted by things including your credit history and credit score, and the valuation of the business. Take care to adhere to their application process and always check that lenders are regulated by the Financial Conduct Authority.

Let’s look at some of the most common types of business acquisition loan.

Secured loans

Secured business loans are backed by an asset such as property, land or machinery. This usually means the business loan will be offered with lower interest rates and more favourable terms, as the asset reduces the risk to lenders. Lenders don’t take ownership of the asset, but should you be unable to repay the business loan they have the right to sell it to cover the outstanding amount. Also, you can’t sell the asset without clearing the debt secured against it.

A mortgage is a good example of this. Commercial mortgages can be used to raise business finance to buy not only the business premises, but to make the business acquisition itself. Just as domestic mortgages depend on income, funding providers for commercial mortgages depend on sales and cash flow. While this can be a useful way to raise funds, you should bear in mind that if the debt becomes unsustainable, the property can be repossessed.

Unsecured loans

Unsecured business loans are more risky for the lender and therefore they are usually more expensive for the borrower. They generally also come with the requirement to sign a personal guarantee. If you can avoid doing that, then you should.

Asset finance

Asset finance involves borrowing money against the assets in the business that you are buying. Say you are buying a business that has a valuable machine, and that machine is fully or at least partly paid for; you could potentially use the value inherent in that asset to raise funds to buy the business, or at least to pay the initial consideration – the down payment. The machine itself would act as collateral for the loan.

Assets that can be leveraged in this way are fixed assets, purchased for long-term use, and include things like machinery and vehicles. They have value on the balance sheet and in the business plan. They can help you to buy a business without putting any of your own money down. The loan is arranged in advance and comes into being on completion – it’s all in the timing.

Alternatively, if the business owns assets that are no longer in use but still have value, selling those to raise business finance makes sense,.

Invoice finance

With invoice finance, you use the value in the debtor book of a successful business to fund the business purchase. The debt must be business-to-business, and there are two basic models: confidential invoice discounting and factoring.

With confidential invoice discounting – CID – the customers pay you and don’t know you’re borrowing against the value of their invoices. You then make the payment to the company lending on it.

With factoring, however, it’s the factoring company that sends the invoice to the client. Bear in mind they can be fierce when chasing late payments, which could damage your relationship with your client.

Invoice finance is provided by specialist lenders; typically you go via a broker who specialises in that type of finance.

Non-Debt financing options

Non-debt financing options are any kind of funding you are not required to repay, or at least are not required to begin paying back immediately. Let’s take a look at some of the most common.

Equity funding

With this, you sell a stake in your company to one or more third parties. This is generally done via a share issue. While you will no longer own the entire company, you can keep control, and investors benefit from the success of the business.

Common equity finance options include angel investors, venture capital, and private equity.

Venture capitalists

In return for equity stakes, venture capitalists invest in start-up and early-stage businesses to help them grow. These companies may be pre-profit or even pre-revenue. Sectors including life sciences, IT, and FinTech are popular options.

Investment may be for, say, a five-year cycle, during which time the business will be expected to grow significantly and so provide a return for the fund.

Equity-based crowdfunding

This is capital provided by individual investors and sourced through an online crowdfunding platform. You set out your case, including details of the business, your expertise, and reasons for buying it, why people might choose to invest, and what they get if they do, the latter being a stake in the company. Any return on their investment depends on the performance of the business.

Seller financing

With seller financing, you buy the business on a deferred basis. This often involves a partial upfront payment – the initial consideration – being made on completion of the sale, but it is possible for payments to be up to 100% deferred. The deferred element is paid via monthly repayments, over time, just as with a bank loan. You would draw up an agreement with the business owners to cover the terms of the purchase.

This kind of arrangement is usually used for smaller deals, or for businesses with unpredictable cash flow, or where there are no assets to finance. The seller still gets their money, but they don’t get it all on day one.

Seek out investors or partners

Rather than going it alone, you can team up with a partner or partners, and/or seek external investors.

Sharing the burden of the business acquisition also means sharing the rewards, so you need to be confident the business can support that. And be sure to draw up a partnership agreement.

External investors might place requirements or restrictions on what you do. That said, there are people who are happy to put money into a business and to sit back and let you get on with running it. However you proceed, you need to make sure all parties are happy with the arrangement.

Use your personal funds

You can, of course, use personal savings or funding secured on personal assets to raise the capital needed to purchase a business. However, a word to the wise: aim not to sign a personal guarantee, and only secure funding against your property as a last resort. If something happens that leaves you struggling to meet your financial obligations as far as your business loan is concerned, the last thing you need is to be in danger of losing your home as well.

Borrow from friends and family

When considering potential lenders, remember that borrowing from friends or family can be a good way to raise funds, especially if your credit rating is below par. Make sure to put things on a formal footing. Draw up a business loan agreement so all parties know where they stand.

Explore further opportunities

When it comes to raising funds and deciding on the right type of financing to buy an established business, there is no one best way. How you do it, and how you structure your deal, depends on you and the business you are looking to buy. For expert information and advice, join Dealmakers FastTrack programme.

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