Business Acquisition Loans: Finance to Buy a Business

How business acquisition loans work

A business acquisition loan is a loan to buy an existing business – a small or medium business, a franchise or a share of one. The lender asks two questions. Can the business, once you own it, repay the loan and still give you an income? And if it cannot, what could the lender sell to recover its money?

That second question is why lenders lend against what they could recover, not against the asking price. The price reflects what the business earns for its owner. The lender's security – the assets it can sell if the loan is not repaid – is only what would still be worth something if those earnings stopped.

What the price is made of

• Goodwill: the value of the name, customers, systems and earnings above the physical assets. It is often most of the price.
• Plant, equipment, fit-out and vehicles, which a lender values at what they would fetch second-hand, not what they cost.
• Stock, usually counted and valued at settlement and paid for on top of the agreed price.
• Sometimes freehold property, when the business owns its premises and they are part of the sale.

The gap between the price and what a lender will count as security is the central problem every buyer has to solve.

Why goodwill is hard to lend against

Goodwill exists because the business is trading well. If that stops – customers leave, a key person goes, the lease is lost – the goodwill shrinks or disappears, at exactly the moment the lender needs to recover its money. A lender cannot repossess a customer list or a reputation and sell it.

So most lenders give goodwill little or no value as security. Some will lend partly against the cash flow of an established, consistently profitable business with clean records, but even then they usually want other security, a solid contribution from you, and the owners signing as personal guarantors.

The practical result: the more of the price that is goodwill, the more of the funding has to come from somewhere other than a loan secured on the business itself.

Business acquisition funding: the usual mix

Few business purchases are funded from one source. Most combine several of the following, in proportions that depend on the price, what the business owns and what you own.

Your own contribution

Cash you put in. Lenders treat it as evidence that you have something to lose and have planned the purchase, and it reduces how much has to be borrowed against assets that are hard to sell.

A loan secured on residential or commercial property

The most common way to fund goodwill is to borrow against property you already own: your home, an investment property or commercial premises. The lender lends up to a set proportion of the property's value, called the loan-to-value ratio (LVR). The money is for the business, but the property is the security – and it is at risk if the business fails.

Finance against equipment and vehicles

Plant, machinery, equipment and vehicles in the sale can often be financed separately, secured on the items themselves. That leaves your cash and property equity for the goodwill, although specialised second-hand items attract less finance than new, widely traded ones.

Vendor finance and earn-outs

The seller carries part of the price, either as a loan you repay (vendor finance) or as payments that depend on results after you take over (an earn-out). Both are explained below.

Buying a business with no money down: is it realistic?

No money down business acquisition is an attractive promise, so it is worth being direct: buying a business with none of your own money is rare. A lender funding the whole price would be lending against goodwill with nothing of yours at stake, which is the combination lenders avoid.

When a deal is described as no money down, the money still comes from somewhere, and the risk moves with it: onto your property, your relationship with the seller or your ownership.

What can reduce the cash you need

• Borrowing against equity in property you already own.
• Vendor finance for part of the price, ranked behind the main lender.
• An earn-out, so part of the price is paid only if the business performs.
• Separate finance for the equipment and vehicles in the sale.
• Buying in stages: a share now and the rest later from the business's earnings.
• A partner or investor who contributes cash in return for a share of the business.

Be cautious with a business advertised as fully seller-financed. A seller willing to wait for the entire price may be confident, or may have failed to sell to anyone putting their own money in. Ask why, and have your accountant test the figures before you take the offer at face value.

Vendor finance and seller financing explained

Vendor finance, also called seller financing, means the seller agrees to receive part of the price after settlement instead of all of it on the day. In effect the seller lends you that part, and you repay it from the business's earnings over an agreed period, usually with interest.

How it works

Your contribution and the main loan fund most of the price at settlement. The remainder becomes a debt to the seller, repaid by instalments or as a lump sum on a set date. The seller may take security over the business assets or shares, behind the main lender.

Why it signals confidence

A seller who accepts part of the price later is betting that the business will keep earning without them. Lenders read that as a sign the earnings are real and transferable. It also gives the seller a reason to make the handover work, because their final payments depend on it.

Documenting it properly

• A separate vendor finance agreement prepared or reviewed by your lawyer, not just a clause in the sale contract.
• The amount, the interest, the repayment schedule and what happens if a payment is missed.
• Any security the seller takes, and over which assets.
• Whether you can deduct amounts from the debt if the seller breaches a warranty or the restraint of trade.
• What happens if you sell the business or want to repay early.

Ranking behind the lender

Your main lender will almost always insist that the vendor loan ranks behind its own, through a priority or subordination deed the seller signs – an agreement that the lender is paid first. It can limit when the seller is paid and stop them enforcing while the main loan is outstanding. That is a normal condition, not a sign of trouble.

Earn-outs: paying part of the price from future results

An earn-out makes part of the price depend on how the business performs after settlement. You pay a fixed amount up front, and further payments are due only if agreed targets – revenue, gross profit or earnings – are met over a set period after you take over.

Earn-outs suit businesses where the seller's price relies on growth that has not yet shown in the accounts, or where buyer and seller cannot agree on value. They reduce the risk of overpaying, because the price follows the results.

• Define the measure exactly, including how costs you introduce are treated. A vague definition is the usual cause of earn-out disputes.
• Agree who controls the decisions that affect the measure during the earn-out period.
• Set out how disputes about the figures are resolved, ideally by an independent accountant.
• Expect your lender to require earn-out payments to rank behind its loan, as with vendor finance.

What lenders check before a loan to purchase a business

A lender assesses the business you are buying and you as its new owner. Expect detailed questions on both, and have the answers ready before you make an offer.

The business you are buying

• Several years of financial statements and tax returns, checked against activity statements and bank statements.
• Normalised earnings: the profit after adjusting for the seller's personal expenses, one-off items and a fair wage for the owner's own work. These adjustments are called add-backs.
• Customer concentration: whether a few customers provide most of the revenue, and whether they are on contracts.
• Owner dependence: how much of the business relies on the seller's skills, licences or relationships.
• The lease: time remaining, options to renew, rent reviews and whether the landlord will consent to assigning it to you.
• Key staff, their entitlements and whether they are likely to stay.
• Working capital needs: the cash tied up in stock and unpaid customer invoices, and the cash to cover wages and suppliers.
• A restraint of trade: the seller's promise not to open or work in a competing business nearby for a set period.

You, the buyer

• Industry experience, or a management plan that covers the gap if the industry is new to you.
• Your contribution, and where it comes from.
• The security you can offer, usually property.
• Servicing: whether the normalised earnings cover the repayments, your living costs and your existing debts with room to spare.
• Your credit history, and the structure you will buy through, such as a company or trust.

A short business plan helps: what you will keep, what you will change, and a forecast for the first year with its assumptions stated plainly.

Due diligence with an accountant and a lawyer

Due diligence is the checking you do after your offer is accepted and before the contract becomes unconditional. The contract should give you time to do it and a right to withdraw if the results are unsatisfactory. Lenders will rely on much of the same material.

Your accountant

• Reconciles the profit and loss to tax returns, activity statements and bank deposits.
• Calculates normalised earnings and tests every add-back the seller claims.
• Reviews trends in revenue, margins and wages, and whether recent results are typical.
• Advises on the structure you buy through and its tax consequences.

Your lawyer

• Reviews the sale contract, the seller's warranties and the restraint of trade.
• Checks the lease, the landlord's consent and any franchise documents.
• Searches for existing security interests over the assets you are buying.
• Confirms that licences and permits can transfer to you, and how employee entitlements are handled.

Engage both before you sign anything binding. Skipping them to save on fees is how buyers end up paying for problems the seller already knew about.

Finance to buy a franchise

Buying a franchise, whether a new site or an existing one from a franchisee, adds a third party to the deal. The franchisor has to accept you before the sale can complete, and many lenders want to see that consent, or at least where you are in the franchisor's process, before they commit.

• Franchisor consent: interviews, training requirements and sometimes a minimum amount of your own funds.
• The franchise agreement: its remaining term, renewal rights, ongoing fees and what happens on transfer or exit.
• Fit-out or refurbishment the franchisor requires, which may need separate equipment finance.
• The franchisor's disclosure document, and how other sites in the network are performing.

Lenders familiar with a franchise system may already understand its economics. A new site with no trading history is closer to a start-up than an acquisition, and lenders assess it more cautiously.

Buying out a partner or shareholder

Buying out a business partner or a fellow shareholder is an acquisition in its own right. The advantage is that you already know the business, and the lender can see your role in its history. The difficulty is agreeing a price and terms with someone you have worked beside.

• Check the partnership or shareholders' agreement for a valuation method, notice periods and payment terms.
• Decide whether you are buying their shares or units, or their share of the business assets.
• Arrange the departing owner's release from existing loans and guarantor obligations, which the lender has to agree to.
• Consider paying part of the price over time – in effect, vendor finance from your former partner.

Security is usually the business assets and the property of the remaining owners. The lender will look at whether the business can carry the new debt without the departing partner's work or contacts.

Working capital for the first months after settlement

Settlement is the start of the spending, not the end. Money owed by customers for work done before settlement normally belongs to the seller, so you can begin with little coming in while wages, rent and suppliers fall due straight away.

• Wages and superannuation from the first pay run.
• Supplier accounts, some of which may want payment up front from a new owner until you build a history.
• Stock top-ups, especially in seasonal businesses.
• Rent, insurance, licences and transfer costs.
• Changes you plan in the first months, such as new equipment or marketing.

Build a cash buffer into the plan, or arrange a working capital facility such as an overdraft or line of credit alongside the purchase loan. Lenders look more favourably on a plan that allows for this than on one that spends every dollar at settlement.

Business brokers and finance brokers: who does what

Two kinds of broker turn up in a business purchase, and they do different jobs.

Business brokers

A business broker sells businesses. Specialist business brokers, whether in Queensland, Melbourne or anywhere else, list the business, prepare information for buyers and negotiate the sale. They act for the seller and are usually paid by the seller, typically as a commission on the sale. Their job is a good result for their client, not for you.

Some advisers act for buyers instead, finding and negotiating a business on your behalf. They are sometimes called a business acquisition broker or buyer's agent. You pay them, so agree the fee and what it covers in writing.

Finance brokers

A finance broker arranges the loan. A commercial finance broker compares lenders, prepares the lending submission and manages the process to settlement. Finance brokers are usually paid a commission by the lender they place you with, and some also charge you a fee. Ask how they are paid and whether that depends on which lender you use.

Steps from offer to settlement

1. Before you make an offer, work out your contribution, the security you can offer and the repayments the business can carry.
2. Make the offer subject to finance, due diligence, the lease assignment and, for a franchise, franchisor consent.
3. Complete due diligence with your accountant and lawyer, and renegotiate if the findings warrant it.
4. Give the lender the financials, your details and the contract. It will usually value any property security and may value equipment.
5. Receive a formal loan offer, review it with your lawyer and accept it.
6. Obtain the landlord's consent to the lease, and any franchisor consent or licence transfers.
7. Sign the loan and security documents, including any priority deed with the seller.
8. Settle: count the stock, pay the price, take over keys, systems and passwords, and begin the seller's handover period.

How long this takes depends as much on people outside your control – the landlord, the franchisor, valuers and the seller – as on the lender. Set a settlement date that gives each step room, and make sure the finance condition in the contract runs long enough.

What business purchase loans cost

The cost of business purchase finance varies widely between lenders and deals, so compare the total cost, not the interest rate alone. Expect some or all of the following.

• Interest, which is usually higher on loans that rely on business cash flow than on loans secured on residential property.
• An establishment fee charged by the lender to set the loan up.
• Valuation fees for property, and sometimes for equipment.
• The lender's legal costs, which you usually pay, as well as your own lawyer's fees.
• Your accountant's due diligence fees.
• Broker fees, where a broker charges you directly.
• Government charges on the transfer, where your state or territory levies them.
• Lease assignment costs and, for a franchise, transfer and training fees.

Ask each lender about ongoing fees and the cost of repaying early. Private and non-bank lenders may lend where a bank would decline, but usually at a higher cost. That trade-off is worth weighing against what you lose if the deal falls through.

Risks of buying a business with borrowed money

Overpaying for goodwill

If the price rests on earnings that do not hold up, the goodwill you paid for shrinks but the loan does not. Base the price on normalised earnings your accountant has verified, and use an earn-out or vendor finance where the seller's figures depend on future growth.

Signing as a personal guarantor

Lenders to small and medium businesses almost always ask owners and directors to sign as personal guarantors, which makes you personally liable if the business cannot pay. If the security includes your home, your home is at risk. Understand exactly what you are signing, and get independent legal advice first.

Handover risk

Customers, staff and suppliers may follow the seller rather than the business. Negotiate a handover period, introductions to key customers, a restraint of trade and warranties about the accounts, and consider keeping part of the price as vendor finance or an earn-out.

When this finance is the wrong choice

If the business can only meet the repayments when everything goes to plan, if your home is the only security and you could not cope with losing it, or if the business depends on a departing seller who cannot be replaced, a smaller business, a larger contribution or walking away may be the better decision.

How can I get a loan to buy a business through ADS.finance?

ADS.finance is a loan marketplace, not a lender. It does not lend money, does not give financial or credit advice and does not recommend any lender or loan. You post one loan request, and ADS checks every loan request before it goes live to the network.

The network is 200+ Australian Finance Providers: private lenders, non-bank lenders, mortgage brokers and commercial finance brokers. ADS checks each provider's ABN and business details before an admin approves them. Lenders and brokers can ask you about your request, and one can take it on and contact you. You are never obliged to go ahead.

Posting needs no credit check. ADS.finance does not access your credit file, and a lender you later choose to deal with generally needs your consent before it checks it.

Requests are for property, commercial and business finance from $100,000; ADS does not do personal loans. Each lender and broker sets its own rates, fees and lending criteria and is responsible for its own licences and disclosures.

What to put in your loan request

• The business, its industry and location, and whether it is an existing business, a franchise or a partner's share.
• The price, how much you need to borrow and how soon you need the money, including the settlement date.
• Your contribution, and the security you can offer: property you own, and the equipment or vehicles in the sale.
• Any vendor finance or earn-out the seller has agreed to.
• Your industry experience and a summary of the business's recent earnings.

You do not need the full financials to post. A provider that takes your request on will ask for them.