Financing the Purchase

Financing the Purchase
When you have settled on the price, the question of how to finance the purchase will arise. There are a number of sources to approach if you need to arrange finance to complete the purchase.

Whichever organisation you approach, financing a business with a past track record of good profitability is much easier than financing one that is new or has a poor track record.

Many financiers such as banks, will arrange finance based on the asset value of the business, as well as its profitability, but may not include the goodwill portion.

One of the sources not to be discounted is an approach to the seller. Many sellers are happy to provide a portion of the financing to help with the completion of the sale, especially if the seller is retiring and does not require all the cash up front. The seller may require a solid repayment schedule, plus a good interest return.

The good thing about seller funding is that he/she is interested in doing everything possible to assist in the completion of a deal, whereas if you approach an outside funding organisation, their interest is mainly on what return they can get and what security is available for them to use. They don't necessarily have much interest in whether you can complete the purchase or not, as they get nothing from the deal.

You will need sufficient capital to arrange for the purchase price of the business, as well as funds that will enable you to make any additional changes (for example, to the offices or premises) and extra cash to operate the business until it can generate its own revenue. Make sure you have a reserve amount set aside to meet any unexpected costs and that will allow for any miscalculations on your part as to the projections or unrealised expectations.

You should think well beyond just getting enough money to complete the deal. Think a little bit ahead about what will happen when you take over and you go to your bank and find that there is not enough cash to run the business or grow the business, or make any changes necessary for it to run efficiently and profitably.

Generally, you should look towards having enough to set up, buy, make any changes and allow at least three to six months operating costs to be met because you will need all that time for the business to be self-supporting.

Types of Capital
There are two types of capital that you can look at:

(a) Equity capital.
This is capital you can obtain by allowing other people to come into the business and buy a share. This capital is good because you do not have to pay any interest on the money injected into the business. On the other hand, it is not good for you because you have to give away part ownership in your business and allow that party to have some say in running the business.

(b) Debt capital.

This is capital that is borrowed as a loan and has to be repaid with interest. This is good capital because the lenders generally don't have a say in how you run the business and yet it is bad capital because you have to pay interest for the use of the money. It is also bad because security offered for that loan is usually over the business or major assets, and this means that if you cannot repay the loan the lender can move in and take the asset or your business over.

Equity capital is called risk capital because those who provide the equity capital take the risk that the business can fail, but on the other hand their demands for a return can work out and they can reap substantial benefits from its success.

If you don't use equity capital, then debt financing is the only other option if you don't have any private funding yourself, put together from your own sources or from your family and associates.

You can borrow money for completing the purchase of a business by obtaining a loan either through security of your insurance policies or by raising a mortgage on your home or other real assets you may have.

If you can avoid it, don't raise finance on your home. Best to see if the lender will take security over the assets owned by the business. As much as possible, keep your personal and family assets out of the "firing line" in case things don't work out as planned and the business goes under.