Considering buying a business? Are you asking yourself, from where will I get the money?
There are two cash requirements to think about when you are considering buying a business.
How much cash do you need for a down payment?
How much cash is required to close the sale and start out on a sound financial footing?
These are two different uses for your cash, and you would be well advised to look at both carefully as you plan for the purchase of a business.
The majority of acquisitions will require funding from a variety of sources.
A common 'rule of thumb' for financing sources is:
1/3 Buyer's Own Funds - cash or a secured line of credit
1/3 From The Seller – the seller finances a portion of the transaction over time
1/3 Lender Loan - bank financing
While the above 1/3 buyer cash requirement is a good rule of thumb, there are options to find flexible and aggressive financing that will help reduce your need for cash. One situation that reduces your need for cash is a Seller who is willing to carry more of the purchase price than average. While this is a good goal for the business buyer, keep in mind that businesses with stronger earnings tend to close with higher cash levels than businesses that are less profitable. So in many cases, you get what you pay for.
Securing lender financing can often be the "hold up" for a lot of deals. It is important to focus on what lenders typically look at when making financing decisions as this will allow you to better prepare your financial resume for when you may need financing. Knowledge of the 4 C’s can help you get the deal with the terms you want.
The 4 C’s of Obtaining Lender Financing
Character – how have you handled previous credit granted? Credit bureau information and previous loan history with other lenders will be taken into consideration
Capacity – does the business generate sufficient cashflow to repay the loan?
Collateral – what is the value of the assets being pledged as security?
Conditions – a complete project assessment to determine the use for the funds and the source of other funds contributing to the project
Common Business Purchase Cash Requirements
In addition to the cash you will pay the seller for the business, there will be a host of additional demands for cash. These costs should be taken into consideration when assessing your cash needs. It will help you determine the price range of the businesses to target as realistic acquisition candidates.
Here is a list of some of the larger, more common costs associated with business purchases:
Legal costs, to prepare the purchase and sale agreements
Accountant’s fees, for advice on structure, tax, and to help set up your operations
Inventory counting services fees
PST on equipment purchased
Vehicle registration & licensing fees
The largest drain on cash is to have sufficient operating cash (working capital) to fund operations while you learn the business. It is a good idea to have at least 6 months of living expenses in cash to live off of as you grow the business. It results in a stronger business and reduced risk to you.
Negotiating an optimal transaction structure can do a lot to reduce the risk of large cash requirements. For example, if you can negotiate surplus working capital as part of the deal, the business you buy will have this surplus to draw on from day one. This can reduce or eliminate the need for your cash reserves.
Assemble your team of knowledgeable advisors that can negotiate a structure that works for you and the other parties involved.