Understanding Financing When Buying Your Business
Understanding Financing When Buying a Business
“Understanding where you stand with your own finances, your bank, and the business cashflow form the pillars of buying your own business ”
So you have come to the point where you have decided to take your career down a different path and have started to consider owning your own business. You have connected with a few brokerages in your city, figured out some of your own skill sets and want to kind of figure out what your purchase price point would be depending on whether you take on any bank debt or not. There are few different kinds of financing that are available to you depending on the size of the business you are planning to buy. Most business sales involve the buyer injecting a percentage of their own cash, a percentage of financing the seller is willing to offer, and lastly, Bank Financing. Understanding this structure in a rudimentary way, will help you to really understand what your purchase price range is. This is tremendously useful when talking to brokers about their listings, as it shows that you are a serious buyer who know what they want and what they qualify for.
A typical example could be the buyer injecting 25%, the Vendor note of 20% and the Bank offering a term loan for the remaining 55%. Again this is by no means a hard and fast, and no two deals are the same. Having a relationship with a commercial banker beforehand is key, as they can also guide you through the process of what you would qualify for.
Understanding Bank Debt
It’s important to understand what you would qualify for in terms of bank debt, and this is tied in some ways to a few simple metrics. The simplest of them all is your personal networth, (personal assets minus, personal liabilities), as you may have a business with strong cashflow to support the borrowing but if you don’t have the networth for the personal guarantee, then a bank may not be willing to lend to you. The second metric is the business cashflow, and if the cashflow can support the new borrowing. Again this will depend on the type of borrowing, collateral, risk on the business, etc. While these are only two of a multitude of metrics, they are the best to get started with.
Every so often we come across buyers who believe that they can buy a business with none of their own cash down, and use only bank/seller financing. To be blunt, this happens in very rare situations, or with very distressed businesses. In my experience as a banker and as a broker, banks will want to see you as the buyer put a portion of your own cash as ‘skin in the game’. Lastly, most banks will take a charge on the business title and the assets of the business, along with a personal guarantee, for the circumstance when the business is unable to meet its debt obligations. If you are interested in learning more about what ratios banks look at feel free to setup a call with one of us and we would be delighted to walk you through the process.
Understanding Vendor Notes or Vendor Financing
When you are looking to buy your own business, it doesn’t hurt to ask the seller if they are willing to finance a portion of the deal. In our experience a pretty significant portion of our deals have a Vender Take Back (VTB) or Vendor financing available, and depending on the deal, this can range from 5% to 30%. Vendor Notes are common as they show the business owner believes in the continued viability of their business and are an act of good faith. Obviously, the seller will want to offer as little as possible, and every buyer will want to get as much as possible. Ultimately, this is still debt. It depends on the amount of debt you are taking on, the terms and if the business cash flow can service all the borrowing. Most seller financing is subordinated to bank debt, and can range from a term of 2 years up to 5 years.
In conclusion, as a buyer it is crucial that you get setup with your own Bankers, Lawyers, and Accountants, before you start your search for a business, as they are very important to have when you want to pull the trigger. Knowing your own price range is very important when reaching out to brokers, so you don’t waste your own time evaluating and making offers on businesses that you cannot get financing for. If you want to learn more about the people we work with, don’t hesitate to reach out, and we will connect you with our trusted partners.
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