How should I fund the purchase of an existing business?

How should I fund the purchase of an existing business?

SHARE

When buying an existing business, the first option usually is to contact the traditional banks for finance. It all depends on the type of business and whether it is a new start up or the taking over of an existing business,” explains director, Louis van Zyl, of Renwick Business Brokers.

A deposit is required

Banks need some deposit as well as collateral. The deposit will depend on the type of business and the credit worthiness of the buyer. The deposit can be as high as 50% of the purchase price.

“A finance deal can also be structured – stock can be financed with an overdraft and equipment either with a lease agreement or a hire purchase agreement. Financial institutions are not keen to finance goodwill,” says van Zyl.

Bank Financing

Banks take the following in to account when considering the financing of a business:

  • Trading history of the business such as: How long in operation, how many previous owners, products to be sold, where located, customer base, reliability of suppliers, competition and lease agreement.
  • The assets – equipment belonging to the business – will be used as collateral and thus the banks, as well as the buyer, must ensure that these are in good working order.

As mentioned above, if the assets are new, these can be financed with a lease or hire purchase.

Debtors and stock can be ceded

Debtors and stock may be ceded to the bank as part of the collateral and thus the bank will need at least monthly certified debtors’ schedules.

Every cent that any financial provider lent to a borrower must be repaid, plus interest on the capital. Because of this the banks will have to ensure that the business is profitable and will be able to meet the monthly repayments as well as be able to continue to provide an income for the owner.

 

Entrepreneur-Newsletters
Entrepreneur’s daily tips & insights delivered direct to your inbox.

Do you have the right skills?

As a business and the owner are closely linked, the banks will ensure that the operator has the necessary skills and knowledge to run the type of business being bought. Whenever finance is applied for, the bank will need surety for the money lent. They must ensure that, should the business not succeed, the borrower will be responsible to repay the monies lent.

Other Funding Vehicles

“There are some financial institutions that have other finance options available – Khula Indemnity Scheme requires less deposit and Business Partners have other requirements, but all will take in consideration these aspects as mentioned above. Another way of finance which is easily obtainable is Seller Finance. In this instance the seller will finance part of the purchase price at a rate and repayment term as agreed upon. Usually the seller will retain shares in the business as collateral,” explains van Zyl.

The entity will want to see that your research and preparation – as presented in your business plan – supports the notion that you business has a market and the ability to be profitable and sustainable. Most importantly from their perspective, you will need to convince them that the company will be able to generate sufficient revenue to cover costs and repayment of their loan.

Finding finance to buy an existing business when there is little security

Before you try to raise money to buy the business, check the financials of the business you are thinking of buying.

Is the business worth the price?

Make sure that the business you are buying is worth the purchase price and ask a professional such as an accountant to investigate the profitability of this business. You must be prepared to assess all business records and search for any “skeletons in the cupboard.”

This information can be found by obtaining important business documents such as financial statements, tax returns, leases, etc. You can also gain information through observation and by talking with employees (if given permission by the seller).

You do not want to buy the business and then find that the appraisal was inaccurate, or the former owner’s misrepresented the company’s financial situation. If the owner had a bad reputation, you would inherit prejudices of former customers and suppliers.

Alternative financing methods

Sometimes finding finance for an entrepreneurial venture is not always possible, but not having capital isn’t the end of your business idea. There are other options including bootstrapping, a partnership or an angel investor.

Take a partner on board

Consider finding a partner who has the money to invest. There are two kinds of partners – active in the business, or silent. A silent partner invests capital in a business but chooses not to play an active or public role in managing the day-to-day affairs of the company. It’s vital if you go this route to draw up a partnership agreement.

Angel investors

Angels come in two varieties: those you know and those you don’t know. They may include professionals such as doctors and lawyers; business associates such as executives, suppliers and customers; and even other entrepreneurs. Angel investors vary widely, but they are typically willing to accept risk and demand little or no control in return for the chance to own a piece of a business that may be valuable someday.

 

Entrepreneur
Entrepreneur Magazine is South Africa's top read business publication with the highest readership per month according to AMPS. The title has won seven major publishing excellence awards since it's launch in 2006. Entrepreneur Magazine is the "how-to" handbook for growing companies. Find us on Google+ here.