Borrowing money to buy a business

Borrowing money to buy a business

Buying a business doesn’t come cheap. Sometimes you need to look for funding elsewhere, besides your own. Which funding scheme suits you and your business needs best?

Besides using your equity fund, or your own money in investing in the purchase of a business, you might be in a situation where you need to look for funding elsewhere. If not a necessity, you may still deem it a better financial decision (read: fewer risks) to use funding elsewhere in the purchase of a business.

The following are options you may consider besides your equity fund:

  • Bank loans
  • Private investors
  • Venture capital
  • Government assistance
  • Vendor finance

Bank loans

In order to successfully get a loan application from a bank approved, you need to provide certain required documents and satisfy a set of criteria. Besides these, you must have a purposeful reason for applying for a loan—a strong business case.

A strong business case involves informed and sound financial projections, as well as convincing evidence of potential income and viability. To anticipate potential loss, a collateral will be required by your lending bank or financial institution, which will undergo valuation to make sure it can cover the loan’s value.

A sound business plan includes clear and achievable business objectives, strategies to achieve these objectives, and your target market as well as ways to strengthen this base. Your plan must be able to show and demonstrate to the bank that you know where your enterprise is headed (under your ownership and/or management). It will be the basis of your business’ future performance, as well as for demonstrating its feasibility in the long run.

Paperwork will also be required by your lending bank, so prepare the necessary documents beforehand to facilitate the ease and speed of your loan application. In general, you will need:

  • The current balance sheet of the business
  • Full tax return of the business which is less than two years old
  • Profit and loss statement for the business which is less than two years old
  • Details of your qualifications, and if any, information on your previous experience(s) in running a business
  • Details on your personal assets and liabilities
  • Information about the equity you plan to invest in the business, and
  • When required, a forecast of expected profit and loss, and cash flow, for the first two years of running the business

Learn more about the things you need to apply for a bank loan here.

Your lending bank will also need an appraised value of the business you plan to purchase. This will be done by a professional appraiser—a certified accountant or a valuation specialist—to assess its worth, if it’s a property-based establishment. For non-property-based businesses, the value will be calculated via multiple factor—three times its earnings, for example.

Before finally deciding on a loan term, determine whether a short-term-lower-interest arrangement or a long-term-higher-interest scheme works best for you. Here, you need to consider your monthly payment’s impact on your cash flow, especially during the early phase(s) of your business.

Private investors

Those who find it difficult to take out loans from traditional sources, like banks, may look into other alternatives like accessing funds from private investors. These investors are willing to take certain financial risks, albeit only calculated ones.

If they see that your new business venture has great potentials, they will provide you funding, given you will promise them high returns on investment within a specific time period.

Venture capital

Besides providing you with the initial funds in the purchase of a business, venture capitalists may also serve as partners due to the high stakes included in the entire undertaking.

In Australia, entrepreneurs may seek the assistance of private investment networks to match them with the right private investors. Once the match has been made, it is advisable that you engage the services of an accountant and/or lawyer to draft the legal agreement for the mutual protection of interests of both parties—you and your private investor(s).

Government assistance

Federal, state, and local assistance are extended to SMEs that meet certain eligibility criteria. Besides this, the government also makes available to you advice and information in securing funding from private investors/investment firms or in securing loans from banks and other financial institutions.

For more information, you may contact or visit your local Small Business Centre (SBC) for guidance.

Vendor finance

Another method you may look into is vendor financing, where a loan is formed between vendor and purchaser on the agreed purchase price of the business. The loan will be repaid out of the ongoing profits of the business, with the specifics of the agreement dependent on how you and your vendor have negotiated.

Also, consider the following to identify which financing option best suits your needs:

  • Funding availability — Obtaining a loan is the best way to go when you need a lump sum. Otherwise, if you require ongoing access to credit, consider a personal overdraft or other similar funding schemes
  • Interest rates — The key is to look for the credit option that features the most competitive interest rates
  • Fees and charges — Avoid financing options that inflate your debt with more fees and extra charges. Always compare loan options and select the best one that doesn’t add more financial risks to your new business venture
  • Flexible repayments — Besides competitive interest rates, always select the financing option that also provides you a convenient repayment arrangement. Convenient repayment means it allows you to pay the loan early without added charges or it gives you more options and access to extra repayments

Besides the financing options discussed above, other financing alternatives you may also consider include:

  • Credit card financing
  • Overdrafts
  • Interest-free financing
  • Line-of-credit loans
  • Bad credit business loans

Credit card financing

Especially effective in purchasing business-related items, you can use your credit card to cover cash shortfalls.

Bear in mind, though, that the power of your credit card depends on your credit limit, as well as how wisely you utilise it.

Overdrafts

Overdrafts allow you access to ready money without using your credit card.

Similar to personal loans, you may create an overdraft on your account and set a specific access limit for a revolving line of credit. With overdrafts, most often, you only have to pay for the amount you use.

Interest-free financing

Retailers offer interest-free financing that allows you to take various items home while paying for them in a lump sum or instalments before the conclusion of the interest-free period.

Line-of-credit loans

With line-of-credit loans, you may withdraw funds as often as you need, up to a set amount limit. This alternative is also a bit similar to credit card and overdraft financing, but with line-of-credit loans, you’ll need to pay interest on the amount you owe.

Bad credit business loans

This is the alternative to consider when your credit history or rating leaves much to be desired. A caveat: expect higher fees and interests when engaging or taking out this kind of loan. Bad credit loans also almost always come with stricter debt repayment requirements.

These financing options come with the following features you also need to consider:

  • Interest rates and fees
  • Minimum loan amounts
  • Repayment options
  • Loan restrictions

Interest rates and fees

Interest rates and/or fees vary, of course, depending on the kind of loan you decide to apply for.

It is best to fully understand your business objectives first to also better identify which loan suits you best. Fees also depend on every credit option. Make sure you thoroughly understand fee structures and their entailments, from application to account-keeping fees, and more. Simply, always opt for the loan with the most competitive rate, so you’re sure your business costs are minimal, especially during your initial phase of operations.

 

Minimum loan amounts

The question to ask here is, would you be able to ensure sufficient funding for your new business and your business needs? Remember that the amount of credit available to you will vary and depend on the line(s) of credit you decide to utilise.

Repayment options

Personal credit lines will either require you to pay a minimum amount to a specific time schedule, or specific repayments via monthly instalments.

To avoid paying interest, in some cases, you might need to pay the entire amount due within a specific date to avoid growing interest. Again, the best way to go is by selecting the repayment structure that best suits and works with your business objectives and your current budget.

Loan restrictions

Different credit options come with different restrictions. Once you completely understand this, it’d be easier for you to assess your business objectives and select the right funding scheme or set of funding schemes that works best for you.

If still unsure, talk to a trusted lawyer and/or accountant with proven expertise on the subject matter, to help you make a more informed decision.

Taking into account the above considerations will make it easier for you to select the best financing option(s) for your business purchase. Bear in mind, too, that you are giving yourself the best chances of success when you’ve chosen to invest in the purchase of a business that best matches your professional experience and your passions. Inexperience will almost always lead to devastating financial—and personal—consequences.

Couple experience with passion, and you not only ensure your business thrives financially, but also create a strong business identity—a distinct brand, a soul.

Borrowing money to buy a business
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