Finance to buy an existing business or franchise

Buying a business can be difficult to finance through a bank, particularly when much of the purchase price relates to goodwill rather than property or other tangible assets.

But a bank saying no doesn't necessarily mean you can't finance the purchase.

There are second-tier business lenders that will consider lending towards the purchase of an existing business or franchise. Rather than relying primarily on property security, they can look at the strength of the business you're buying, your experience, your own financial contribution and whether the business is likely to generate enough cashflow to support the lending.

NZ Business Finance works with a range of non-bank lenders that consider business and franchise purchases.

How do business purchase loans work?

A business purchase loan provides some of the money required to acquire an existing business or franchise.

Typically, the purchaser contributes a significant amount of their own money and the lender funds part of the remaining purchase cost.

As a broad guide, second-tier lenders may consider funding somewhere around 50–75%, with the purchaser contributing approximately 25–50%.

Those aren't fixed lending ratios.

How much a lender is prepared to provide depends on the business being purchased, the purchaser, the financial performance of the business, the amount and quality of goodwill, available security and the overall structure of the transaction.

If the purchaser has borrowed personally to help fund their contribution, that may also be considered. Different lenders take different approaches to personal debt when assessing the overall transaction.

Why use a second mortgage for business finance?

The lender is assessing the business as well as you

When you apply for an ordinary business loan, much of the assessment is about the financial position of your existing business.

When you're borrowing to buy a business, the lender has something else to assess:

Is the business you're buying actually worth buying?

Expect them to look closely at the proposed purchase.

They'll want to understand:

• How the business was valued

• Whether the purchase price appears reasonable

• Historical financial performance

• Profitability and cashflow

• How much the existing owner has been taking from the business

• How much the new owner intends to take

• Existing contracts

• Confirmed bookings and forward work

• The customer base

• How dependent the business is on its current owner

• Plant and equipment included in the purchase

• Other expenditure required after settlement

• Working capital requirements

• The purchaser's plans for the business

In other words, expect questions.

Lots of them.

The lender's questions are questions you should be asking too

It can sometimes feel as though a lender is making a business purchaser jump through hoops.

But there's another way to look at it.

If you're about to put a substantial amount of your own money into buying a business, many of the questions the lender asks are exactly the questions you should be asking as part of your own due diligence.

Why is the business worth what the vendor is asking?

What happens to sales when the existing owner leaves?

Are customers loyal to the business — or to the person who currently owns it?

Is the equipment going to need replacing in six months?

Is there enough working capital to operate after you've paid for the business?

Are the forecasts realistic?

Are existing contracts actually transferable?

What will you need to take out of the business to live?

A lender asking difficult questions isn't necessarily a bad thing.

Those questions can help expose risks in the purchase before you've committed both your money and several years of your life to it.

How important is my industry experience?

Very.

The lender isn't only assessing the business. It is also assessing whether you are a credible person to take it over.

Relevant experience can make a significant difference.

Strong scenarios can include someone:

• Buying the business they already work in

• Buying a business in an industry they know well

• Buying a second business similar to one they already own

• Having substantial management or operational experience relevant to the business they're purchasing

An employee buying the business they already work in can be particularly straightforward to understand. They may already know the customers, employees, suppliers and day-to-day operation.

But you don't necessarily need to have worked in that particular business before.

The lender wants confidence that you have the skills and experience required to make the business work after the current owner leaves.

Do I need to own property to get a business purchase loan?

Not necessarily.

Property ownership can strengthen an application, but it isn't always required.

Where the business being purchased is strong, the purchaser is making a meaningful financial contribution and they have significant relevant experience, some lenders will consider funding the purchase without relying on residential property as security.

That's one of the important differences between some second-tier business lenders and traditional bank lending.

What security does the lender take?

At a minimum, the lender will generally take a first-ranking General Security Agreement (GSA) over the business.

A GSA gives the lender security over the assets of the business.

Directors will generally provide personal guarantees, and guarantees may also be required from shareholders depending on the ownership structure and lender.

Where the business has significant identifiable assets — such as machinery or equipment — the lender may also take specific security over those assets.

This helps prevent those assets subsequently being used as security to raise additional finance elsewhere without the lender's knowledge.

The exact security requirements depend on the lender and the business being purchased.

How does a lender assess goodwill?

Goodwill can make up a substantial part of the purchase price of a business — and it's something lenders look at carefully.

Unlike a vehicle or piece of machinery, goodwill isn't an asset a lender can simply repossess and sell.

The lender therefore wants to understand what that goodwill actually represents.

For example:

Is there genuine repeat business?

Are there ongoing customer relationships?

Are contracts in place?

Is there confirmed forward work?

How was the goodwill figure calculated?

And importantly:

How much of that goodwill will still exist after the current owner walks out the door?

If customers are primarily loyal to the existing owner personally, that's quite different from buying a business with established systems, contracts, recurring customers and a brand that operates independently of its owner.

The greater the goodwill component of the purchase price, the more important it can be to demonstrate that the value is genuine and sustainable.

What about plant and equipment included in the business?

If you're buying a business with significant plant, machinery or equipment, the lender will want to understand what it's actually getting.

That can include looking at:

• The type of equipment

• Its condition

• When it was last serviced

• Its approximate value

• Its remaining useful life

• Whether significant replacement or repair expenditure is likely after settlement

A business might look profitable on paper, but if the new owner needs to replace $200,000 of machinery shortly after taking over, that changes the financial picture considerably.

These costs should therefore be considered as part of both your due diligence and your finance application.

Don't forget about working capital

The purchase price isn't necessarily the total amount of money you'll need.

The business still needs to operate from the day you take ownership.

You may need cash for wages, suppliers, stock, materials, rent and other operating expenses before enough customer revenue starts coming in.

There may also be fit-out, renovation, repair or other costs associated with taking over the business.

A lender can therefore look at the purchase price together with the working capital and other funding requirements, less the purchaser's cash contribution, when considering the overall finance requirement.

This is one reason it's useful to think about finance early rather than simply working out how you're going to fund the advertised purchase price.

What information will the lender want?

Every application is different, but you should expect to provide fairly comprehensive information.

This may include:

• Financial statements for the business you're purchasing

• Current or interim financial information

• Details of the purchase price and how it was determined

• A business plan

• Financial forecasts

• Details of your industry and management experience

• Your personal financial position

• Details of your cash contribution

• Information about any other borrowing

• A draft sale and purchase agreement, if available

• Details of the business premises and lease

• Information about significant plant and equipment

• Contracts, bookings or evidence of forward work where relevant

• Details of any vendor finance

The lender may ask for additional information once it begins assessing the transaction.

Do I need a business plan?

Expect the lender to want one.

Buying an existing business isn't simply about demonstrating what the previous owner achieved.

The lender wants to understand what happens when you take over.

Your business plan should demonstrate that you understand the business, its market, its risks and what you're going to do with it.

Financial forecasts are also important.

Among other things, the lender will want to understand what you expect the business to earn, what its expenses will be, how much you intend to draw from the business and whether sufficient cashflow remains to meet the proposed loan repayments.

What is vendor finance

Vendor finance can sometimes form part of a business purchase. Vendor finance is when the seller of the business basically lends you some of the money to buy it, in the form of not requiring the whole purchase price up front.

Put simply - Your contribution + vendor finance + loan = business purchase price.

The business lender will take the vendor finance into account when assessing the deal and treat it as a loan that the business has. They will want to see the vendor repayments included in any cashflow forecasts.

It doesn't necessarily replace the need for you to make a meaningful contribution of your own.

The lender will look at the purchaser's contribution, vendor finance, proposed lending and the financial forecasts together to understand whether the overall transaction is viable.

How long can a business purchase loan be?

Loan terms vary according to the lender and transaction, but business purchase lending may be available for terms of up to around five years.

Repayments are generally principal and interest, meaning the loan balance reduces over the term.

The lender will want to see that the forecast cashflow of the business can support those repayments as well as its normal operating expenses and the purchaser's drawings.

Can I get finance to buy a franchise?

Yes (if you meet the criteria). The assessment of a franchise purchase is broadly similar to the purchase of another business.

The lender still wants to understand the purchaser, the financial viability of the business, the amount being invested and whether the proposed business can support the lending.

Some lenders also have established relationships with particular franchise systems or pre-approved franchises.

That can sometimes make the assessment process more straightforward because the lender is already familiar with the franchise model.

It doesn't mean an individual application is automatically approved.

The lender still needs to assess you and your particular transaction.

Can I get finance for a new franchise?

Potentially.

A new franchise doesn't have its own trading history, but the lender can look at the wider franchise system, the proposed location, forecasts, your experience, your financial contribution and the overall strength of the application.

You'll generally need to demonstrate that the master franchisor has approved you — or is in the process of approving you — as a franchisee.

Some lenders may already be familiar with the franchise you're considering, which can assist the assessment process.

When should I arrange finance for a business purchase?

Before you make an unconditional commitment to buy it.

If you've found a business you're interested in, it's worth discussing finance early.

If a draft sale and purchase agreement is available, the lender will generally want to see it.

For businesses operating from leased premises, the lease is also important. The lender needs to understand the arrangements under which the business will continue to occupy its premises after the purchase.

Your solicitor, accountant and other professional advisers also have important roles in the purchase process.

NZ Business Finance can help with the lending side, but obtaining independent legal, accounting and tax advice before purchasing a business is important.

Why use a broker to finance a business purchase?

Business purchase lending isn't particularly standardised.

One lender may be comfortable with a particular industry while another isn't. Some place greater emphasis on property ownership. Others may be comfortable relying primarily on the strength of the business and the purchaser.

Lenders can also differ in how they assess goodwill, purchaser experience, personal borrowing, vendor finance, franchises and the amount of purchaser contribution required.

Knowing which lender is likely to understand the transaction can therefore matter enormously.

We can look at the business you're proposing to buy, your experience, your financial contribution and the overall transaction before approaching lenders whose criteria are more likely to fit.

 FAQs about funding business purchases