Business Buying Finance

buying financeOf all the various financing requests, this is the one least understood. The reason for this is that there are so many people, including some bankers, that have little to no experience in this field.

The financing of a business purchase usually involves structuring a deal that can be accepted by all parties, whilst still being affordable. In many cases the financing required is underpinned by ‘cash-flow’ lending.   That is, advancing funds on the pretext that the bank has no other collateral (security) other than the cash-flow of the business itself.

If you are thinking of buying a business and want to borrow money to do so, you will be met with plenty of opposition as well as misinformation, even from those people that should know better.

Before we go into the details here is one rule of thumb.

Unless its a franchise, if the business purchase is under say $700,000,
then you will more than likely have to provide collateral for any amount you need to borrow.

Different types of businesses can be financed using the business itself as collateral.

Here are some for you to consider:

Franchises

Many franchises can be financed by the major banks using the business itself as collateral.  Franchises purportedly represent a lower risk to banks because they are systemised, have processes and management plans and are overseen by the franchisor in terms of performance reporting. The franchisor is usually collecting a royalty or franchise fee from each franchisee and as such has an interest in supporting the business and helping the owners to turning the business around if it is suffering.

Franchises usually go through an approval process with some of the majors and once complete a percentage of the purchase prices is usually set as the amount the bank will lend you to buy one.   For example, say they set that percentage at 60%, then you will have to contribute 40% of the purchase price plus costs and working capital in order to buy the business.

Manufacturing

When buying smaller manufacturing businesses (with profits less than $1M) you may struggle to find banks that will finance against the business itself. Usually however these types of businesses have some plant and equipment on the balance sheet and you can probably obtain some financing against the value of this machinery.

Management Rights

Management Rights businesses are very popular in areas where buildings made up of a number of apartments are rented out to either holiday makers or to permanent tenants.  The purchase of the business has the RIGHT to manage the apartments as well as collect a commission for letting out these apartments. It’s really income derived by a real estate  property management commission, combined with a salary paid for by the body corporate of the building.   Sometimes the owner of the rights also has a real estate sales licence and can sell the apartments as well and thereby obtain more income. Apartments that are managed by the owners of the rights are considered to be in the ‘rental pool’ and its a multiple of the income derived from this rental pool plus the salary that you are paying for.

Multiples of this income are then added to the value of the residential unit that you have to buy as part of the transaction to enable you to live on site.

So, the income might be $100,000 x a multiple of 4 = $400,000 plus a $400,000 unit = a price of $800,000.

In general banks will usually lend you about 65%-70% of the total $800,000 price. It might be structured as say 80% of the Unit and then 60% of the price of the ‘rights’ which equals $320K plus $240K totalling $560K or 70% of the overall price.

The multiple that is applied to the income amount is a function of return and risk. So, if you are paying 4 times the $100,000 then your pre-tax return for this purchase will be 25%.

On the following page I’ll provide a few examples of how I have structured various business purchases using the business and its cashflow as the collateral for the loan.

 

 

 

 

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