Financing the purchase of a small business

Here, we provide some options for people thinking about buying an existing company.

Many people will have considered purchasing a business either to add to their existing portfolio or as a means of leaving the rat race behind.

Despite the banking institutions’ growing confidence in the small business lending market, securing external finance can still be a daunting process for the uninitiated.

Securing funding is the first step in acquisition

Specialist business transfer agents Intelligent Business Transfer recommend securing your financing before you’ve even settled on your list of potential business acquisitions.

Jonathan Russell of Intelligent Business Transfer says: “Although this is counter-intuitive to many, securing funding and speaking to would-be lenders will ensure you select a business that you can definitely afford. Often the main reason business sales fall down is due to poor planning by the buyer of the business.”

We have outlined the financial options that are available to you.

Unsecured loans

With unsecured loans, you don’t provide any assets as security. However, because the lender is taking on more risk, it may be more expensive for you to borrow. You may need to pay a personal guarantee which will make you liable to fork out if the business fails to pay. Companies with multiple directors might need to provide multiple personal guarantees.

The term and amount to repay on an unsecured loan will vary but if you have a bad credit rating, it’ll be a more difficult option to explore because of that risk to the lender. It may also take several weeks to process.

Secured loans

As you may have guessed, a secured loan requires an asset that you agree with the lender should the business fail to keep up with repayments. Assets can include things land or equipment or a combination of several resources. The lender will have the legal grounds to take the asset if you can’t make the repayments.

The increased risk for you means that these loans are easier to come by with a lower rate of interest and a longer repayment period.

These are better for larger loans of over £250,000 but can take longer if property valuations and increased legal obligations are needed for establishing your asset.

Asset-based lending

Asset-based lending is much like a secured loan. You use your business assets for security including commercial property, your debtor book and your inventory – or a combination of all of them.

You might be able to use the assets of the business you are buying to fund its purchase, but it would be more difficult to arrange.

Bank loan

Securing funding through the large bank institutions can be difficult for anybody looking to purchase a business. Banks tend to look more favourably upon the purchase of an existing business with a proven track record – especially if you can demonstrate your capabilities in the industry – than a start-up or young business.

Banks will want to see your accounts and proof that your business is growing as well as personal accounts to get an idea of your own spending habits. They’ll need to see your business plan, a cash flow forecast and budget plan.

Useful link: – Looking for funding? Find the right finance for your business here

Not everyone will have access to a bank loan. Fortunately, under the Bank Referral Scheme, banks are required to refer people looking for funding to alternative funding providers if they are not deemed creditworthy. The banks would more than likely have to refer the unsuccessful applicant to other providers such challenger banks and peer-to-peer lending services.

Peer-to-peer finance and crowdfunding

Peer-to-peer lending (P2P) and crowdfunding provides financing through a consortium of investors. On the P2P sites, businesses request a specific amount at a set interest rate and lenders fund all or a portion of the loan. As with a standard loan the lender is then paid back with interest over a set period.

Although this type of lending is typically utilised by the actual owners of the businesses, people can still use P2P lending to fund the purchase of an existing business that may otherwise not survive or if they can demonstrate the business’ importance to a local community.

Crowdfunding involves many third-parties investing a smaller amount in a business in exchange for discounts, freebies and early access to products.

Seller loan

Seller loans are more flexible in that they can give you a loan over a few years and you’ve got more flexibility as to how much of the selling price it covers. They can be used to tie payments to the performance of the business.

Take on debt

In this instance you assume some of the debts – but the original lenders would have to agree to switch over the loan to your name. The lender may also need to re-underwrite the loan.

Combination loans

Of course, there’s no reason you can’t combine different types of financing to fund your business purchase the way you want to, possibly even on a larger scale.

Equity funding

Think Dragon’s Den here – you approach investors with your proposition and if they like it, they give you a portion of money in exchange for a share of the business that you’re buying. The risk taken on by them mean that they’ll be expecting greater returns than your average debt provider.

Business angels

Angels tend to focus their efforts on businesses in the early stages so are ideal for those looking to buy a business.

Some have specialist backgrounds which would be helpful in getting your venture going. Even if they don’t, their general expertise will still be helpful. They tend to stay local, focusing on small geographic areas and nearby networks.

Venture capitalists

Most venture capitalists will invest more in businesses with the potential for high returns – normally with a competitive advantage and a strong USP. This method is more effective for buyers who have previously owned a business so that they can prove their track record.

Alternative options

In addition to these, you can pay some of the cost yourself. If you can’t cover it alone, you may have to rely on stock investments, mortgages against your home or your retirement fund. Alternatively, you could use your own funds as a down payment and finance the rest. Be realistic about how much you can put forward – you don’t want to be left struggling to pay for other essentials.

If they’re willing, you could try borrowing from friends and family. This is often one of the last options that people pursue in their search for finance and carries very different types of risks – typically putting more strain on personal relationships.

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Anna Jordan

Anna is Senior Reporter, covering topics affecting SMEs such as grant funding, managing employees and the day-to-day running of a business.

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Small Business Funding

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