How to Finance your Investment
Acquiring a Loan - Key Steps
Using the bank's money to finance the purchase of a business rather than using your own capital will give you significant tax advantages, so speak to your accountant about using borrowed funds and retaining your own cash for other purposes. An obvious advantage of borrowing is that you can amortise or spread the start-up cost over a period of time as profits are generated, rather than paying for it in one lump sum up-front. Let’s look at the steps involved in getting a loan to finance your investment.
1. Select a suitable lending institution or intermediary who has a good business relationship with Business Loan Lenders. Redmako Finance is the specialist finance brokering service for hospitality businesses in Queensland.
2. Prepare a Business Plan.
3. Prepare financials/cash flow forecasts /budgets. 4. Prepare an application for finance detailing:
Background
Personal details
Previous repayment record
Security available
Loan amount required
Source of equity funds
Viability of business
Details of lease terms
Adequacy of working capital
Capacity to repay
Marketability of business
5. Check approval conditions, loan conditions, default situations, penalty for early payout. 6. Look at how the deal is “structured” to maximize the opportunity.
7. Be prepared for and capable of completion of the transaction. It is recommended that you take a pragmatic approach to a deal, and don’t try to “push it through” if it is tight. The financing of the acquisition of the business should be a comfortable process, if it stresses your financial capacity, it will usually either not be approved, or if approved, it will usually lead to a failure in the future.
Capital Required to Operate
It is easy to neglect the total funding requirements in the acquisition of a business. There is often much more than just the business and stock price involved. However, many businesses which fail in the first three years do so because of a lack of finances.
Here is a checklist for assessing the total capital that you will require to complete the transaction.
Capital Required To Operate Stock: Stock Other
Plant: Major Items
Hand Tools & Miscellaneous Leased Equipment
Royalty, Rent, Fees & Licences:
Training Fee Base Franchise Fee Support & Advertising Levy Rental/Royalty
Eftpos Rental Licences
Goodwill/Lease Premium
Security Bond
Administration Expenses:
Insurance (incl. Workers Compensation) Electricity Deposit
Telephone Deposit Stamp Duty
Establishment of Purchasing Entity Legal Costs (inc Security)
Operational Expenses:
Credit Extension/ Debtors/Working Capital Wages (one week)
Opening Promotion Uniforms
Stationery
Sundries/Set Up Costs
Total Capital Required To Operate:
Always consider your TOTAL funding needs, not just the asking price.
Lending Criteria
Bank lending for small business is relatively difficult to obtain – despite what bankers tell us. It is much easier to obtain loan approval to buy a home or a car than it is for a business. Since the Global Financial Crisis (GFC), lending institutions have applied more stringent criteria and requirements upon business borrowers. This does not look likely to change in the near future. Most potential business buyers have an inflated view of their equity, their borrowing capacity and their ability to service the loan.
We need to understand the bank lending criteria with regard to:
The amount of clear equity in the buyer’s real property. Banks will now discount the valuation and reduce the amount loaned against the discounted security, so the buyer’s opinion of their equity in property may be much less than they think.
Banks will require full financial records including tax returns – for several years. Anything less will not be looked upon favourably.
The bank’s risk assessment of the subject business will be far reaching, and will include the assessment of the Future Maintainable Earnings (FME). This risk assessment will be based on the following:
o Sales revenue trends. Is revenue growing or falling? o Revenue volatility. How variable are sales?
o Longevity of the business. How long has the business operated? How long have the current owners operated?
o Competitors. How does the business compare with competition? o Category Killers. Is the business exposed to a dominant new entrant? o Staff. Is there a risk of losing key staff? Can staff be readily replaced? o Special licenses? Are special licenses required to operate the business? o Secure supply. Is the business reliant upon product supply to maintain
profits?
o Customers. Does the business rely upon a handful of key clients? o Secure tenure. What length of tenure remains, and how secure is that
tenure?
Prior to the GFC, lending criteria were relatively modest, but now all financial institutions will only rely upon fully verifiable data to assess loan applications. Tax Return information is the most reliable level of financial information that can be provided for any business as it is provided in a consistent format and it is legally required to be accurate.
With these points in mind, we need to be able to roughly assess the buyer’s ability to acquire a business, and determine if they are being realistic, or not.
Most Common Business Loans
A ‘Line of Credit’ using the buyer’s residential property as security. This is probably the lowest cost source of funds available. It is the most likely funding facility used for lower priced ventures and the repayments can be managed by you. At present funding to 90% of the value of the home can be obtained.
A Business Mortgage Loan uses the equity available in either residential or commercial property as security. These are also low-cost funds (although slightly higher than straight residential) and the term provided is more aligned to generally accepted amortisation rates for business loans. An advantage with these is that as the business grows, lenders are often more willing to listen to increased funding requests for well-run businesses even if they exceed the usual lending values against the security.
A Business Overdraft provides funds for businesses that sell their products or services on credit and sometimes have to wait 30-90 days for the bills to be paid by the debtors. The overdraft can be used to pay the business expenses while waiting for the income from debtors. It can be expensive if not used correctly and it is essential that the amount sought aligns with a well prepared Cash Flow Forecast and is also monitored regularly. The overdraft is usually required to be secured, particularly for smaller, less established operations.
Chattel Finance is used to provide funds to purchase motor vehicles and items of plant and equipment. This can be either Commercial HP or lease. Some companies will consider second-hand equipment purchased as part of a business.
Business Loans using the business’ assets as security can be provided against the value of the business. Lenders generally require that the business has a very strong
background such as well-known franchise, news agency, post office, management rights and real estate agent's rent roll. Business proprietors are also required to contribute their own funds and share the risk. Larger businesses with good business plans,
operating manuals, strong management and cash-flows may also access these facilities.
Debtor Finance is provided by specialised companies and banks to fund outstanding debtors using no other security. More popular overseas than here, it’s somewhat chequered history is now being overlooked for the benefits it can provide to a growing business. Can be used in a start-up situation.
Vendor Finance or Seller Finance is when the seller effectively lends you a component or the whole amount of the money to complete the purchase. Vendor finance is often used to bridge the gap that may exist in negotiations and can be structured creatively to suit both the buyer and the seller.
There are other types of Industry-Specific loans available and you should speak to a qualified professional, such as a Redmako Finance Broker.
Remember, the cash-flow of a business is its life-blood and it is essential that a business has adequate funding in place to allow for growth and changes in the market. Time spent at the outset to prepare business plans incorporating realistic and soundly based cash-flow and profit forecasts will pay large dividends down the track, as well as allowing you to focus on the business.
