Why Would You Need a Loan to Buy a Business?
For most business buyers, purchasing a business is not a cheap objective. While some may have the capital saved up, others need alternative methods of business financing. Regardless of if the target is a small business or a million-pound enterprise, obtaining lines of credit – whether revolving or once-off - to purchase a business is a common occurrence.
It is not uncommon for business buyers to apply for a loan to buy a business. In fact, bank loans are a popular method to finance an acquisition.
Defining a loan is relatively simple. You borrow a specific amount of capital from a lender, and you’ll pay it back with added interest over a timeline set by the lender. In reality, it can become a bit more complicated.
Banks, private equity firms or investors won’t just hand you money upon request. There are terms and conditions, requirements, documents, and other variables you’ll need to consider before applying for a business loan.
Nonetheless, there are multiple lenders across the United Kingdom, and if you diligently prepare and finalise your documents and improve your credit score, obtaining a business loan can be a smooth-sailing process.
Should You Buy a Business or Start One From Scratch?
While starting your own business from scratch is an exciting and rewarding goal for many entrepreneurs, it does come with considerable disadvantages.
As of 2022, approximately 1,843 new companies were start-ups, and a total of 5.9 million businesses were small to middle-market enterprises (SMEs). While SMEs contribute immensely to the success of the economy, a significant proportion of them do not survive. A leading cause of this failure is running out of capital, or an inability to generate new capital.
Starting a business requires meticulous planning, developing a customer base, establishing an effective marketing structure, hiring and training employees, and other important variables. These are expensive and time-consuming costs. Likewise, because start-ups have a high chance of failing, lenders will take on more risk. This makes it challenging to apply for a loan without convincing financial data.
While buying a business can end up being more expensive than starting one, there are multiple advantages:
- You take control of an existing business structure
- The business is likely generating cashflow and is profitable
- A customer base is established
- Employees understand their tasks and objectives
- The business has an established brand reputation
- Patents and copyrights will be transferred to you
Of course, an important advantage to mention is that finding the right business for you can be relatively straightforward. Attributed to the advancement of technology, a simple Google search can generate millions of results that meet a business buyer’s criteria.
BusinessesForSale.com allows buyers to explore different types of businesses for sale, ranging from online businesses to classic brick-and-mortar companies.
Investing in a franchise is another avenue that business buyers often pursue on BusinessesForSale.com, as it is a sustainable and cost-effective route to business ownership – supported by a franchisor and a proven business model.
And for buyers who are interested in expanding their portfolios and acquiring businesses with considerable value, high-value merger and acquisitions targets are readily available on MergerVault, an exclusive service that connects high-value sellers with verified buyers.
There are other advantages to buying a business, but perhaps the most important one is that lenders are more likely to approve a loan to a borrower who wants to buy an established enterprise.
Why Is It Important to Evaluate a Business Before You Apply For a Loan?
If you’re confident that a business purchase is the right choice for you, and you have found a business that meets your goals and criteria, the next step you should take is to conduct a business valuation.
The seller will have a price tag attached to the business, and you’ll need to apply for a loan that replicates that amount (depending on your financial strategy).
Before you buy a car or a home, you would certainly conduct appropriate due diligence to see if the investment you’re making is worth it. It is the same for buying a business. Depending on the type of business you’re interested in, it will likely have common components like assets, legal and financial variables, employees, a customer base and products or services.
These components all hold considerable value and should be evaluated against market conditions and other important variables. It is recommended that you hire a professional intermediary to support you throughout the due diligence process to ensure you fine-comb every detail. This process is important, as it will not only help you determine if the seller’s asking price is realistic but arm you with useful financial data that a lender will require.
To conduct an accurate valuation of the business you interested in, you can use ValueRight, a free tool that provides a pragmatic valuation based on financial details you submit. If you’d like to understand more about the valuation process, you can read our guide on valuing a business.
What Do You Need to Do Before You Assess Finance Options?
Part of the process of buying a business – apart from identifying one and assessing its value – is to conduct research on certain industry and financial considerations before you apply for a loan. These can include:
Understanding your market
Regardless of if you are buying, selling, or starting a business, conducting market research is something a business owner should do consistently. Understanding the market your business operates in will arm you with useful knowledge throughout your business journey. This knowledge includes:
- Making an informed decision by weighing up the risks and opportunities within your industry
- Understanding customer demands for products and services
- Identifying your competitors
- Incorporating market research into your business plan
- Enhance your marketing efforts
Generating a sufficient down payment
Similar to a deposit, a down payment is often used to secure a large purchase, like a car, house or business. The percentage of the down payment will often depend on the lender’s criteria.
For example, if the business you’d like to purchase costs £500,000, and the lender requires a 20% non-refundable down payment, you’ll be required to pay £100,000.
Depending on the purchase price of the business you’re interested in, down payments will need to come out of your own pocket. However, down payments are often a gesture that you’re committed to the purchase, and lenders will be more likely to approve a loan.
Funds to cover interest rates
Obtaining a loan to fund an acquisition will result in interest rates that you’ll need to pay back over time – usually in monthly payments. Often, a high credit score results in low interest rates, but a poor credit score might result in higher interest rates to protect the lender. The purchase price of the business will also impact the interest rates that you’ll pay.
If you can afford to cover your interest rates, it is highly recommended that you put a financial plan in place that accounts for details and potential interest rate increases. If you are not confident that you can pay back these instalments with interest rates, a loan may not be the most sustainable option for you.
Credit score considerations
If you want to borrow money from a source, you need a sound credit score. A credit score demonstrates if you can manage debt, so lenders can assess the risk they’ll take on when they loan you money.
In the United Kingdom, there are three credit rating agencies: Experian, Equifax, and TransUnion. For Experian, a ‘good’ credit score is between 881 and 960. For Equifax, an excellent credit score is between 811 and 1,000. For TransUnion, an excellent score ranges between 628-710.
Each agency offers options to sign up for a credit score account with ease. It is recommended that you understand your credit rating before applying for a loan.
A debt-to-income ratio is another method that lenders will use to determine if you can manage your money and make monthly payments on time.
A debt-to-income ratio calculates your monthly debt payments and divides them by your gross monthly income. Generally, if you have a significantly high debt-to-income ratio, lenders will be wary of approving your loan.
To illustrate this, here is an example:
Amy earns a gross monthly income of £7,000 and has the following monthly debts:
- Mortgage = £2000
- Loan = £500
- Other debts = £300
Total debt payments = £2,800
Her debt-to-income ratio would be: £2,800 / £7,000 = 40%
Cash reserve to pay closing costs
When a business is sold to a new owner, there are often miscellaneous closing expenses that are incurred. Usually, a seller and buyer will need to discuss and negotiate who will be responsible for paying those costs. These closing costs will vary depending on the type of business you are buying and the deal structure, so there is no clear-cut answer to how much you’ll need to save. What’s important is that you keep this in mind throughout the process, and ensure you have a safety net to fund these costs.
Some costs that may need to be negotiated include:
- Insurance policies and existing liabilities
- Taxes (seller’s responsibility)
- Accountancy fees
- Lease deposits
- Intermediary fees
- Legal fees
- Loan fees
When applying for a loan to buy a business, a lender will want to know every detail, opportunity, and risk of your venture. In an acquisition business plan, you’ll need to provide insights on the business’s history, strengths, financials, and other relevant information.
You’ll also need to explain how you’ll contribute to its growth and financial success. You can find a business plan tailored to bank loan applications here.
Negotiating finance terms that suit you
Negotiating is a common occurrence in our daily lives and negotiating the terms of your loan are not exempt from this.
There are hundreds of financial institutions in the United Kingdom, and borrowers often underestimate and overlook the possibility of negotiating term loans with lenders. Remember, there are fine details of terms that are easily negotiable – but could be overlooked without adequate research.
Before applying for a loan, always conduct research, prepare negotiation points, and seek support from a professional broker who has more knowledge and expertise on negotiating term loans.
Types of Loan Funding Available to You
The next section of our guide will run through different finance solutions available to you, but if you’d like to first speak to a BusinessesForSale.com finance provider about your options, you can click here.
Now, let’s run through some loan options you can consider. Remember, you will still need to research and evaluate which option will be best for you.
Simply put, an unsecured loan doesn’t require collateral. It takes the same structure of a loan (paying back with interest), but you can discuss a repayment schedule that suits your financial abilities. These are best suited for small business owners.
You can explore MoneySuperMarket for unsecured loans.
If you need to borrow over £25,000, a commercial mortgage might be best suited to you. You can use a commercial mortgage for property purchases or development, refurbishments, or purchasing equipment – amongst other things.
You can explore Barclays for commercial mortgages.
Asset financing helps you access assets that your new business may need, like equipment or vehicles. If you already own assets, you can also use this type of lending to extract value from them or use them as security when applying for a business loan.
You can explore asset financing with Funding Options.
This is a type of asset finance whereby assets on your balance sheet are used as security against loans. This can include physical assets or intangible assets, like intellectual property (IP).
You can explore British Business Bank for asset-based lending information and eligibility checks.
Other Sources of Funding that Might Benefit You
As we mentioned previously, getting access to funding is not impossible, and there are multiple institutions and individuals that have access to capital. Below are some alternatives to the funding mentioned above:
An angel investor is an individual who has access to a significant amount of capital and uses this capital to fund start-ups and entrepreneurs in exchange for equity of the company.
A simple Google search will give you access to hundreds of angel investors, but you can also research The Angel Investment Network.
Business grants are an effective way to gain access to free funding, but they are highly competitive, and it may be difficult to find a grant that is designed specifically for business acquisitions. However, they are valuable for funding certain business ventures, like equipment purchases, research and development or other growth projects. Grants usually have specific criteria, conditions and requirements, and the application process can take some time. If you need access to capital quickly, a grant may not be your best option.
Nonetheless, our guide on small business grants details multiple grants available to small businesses.
Government-guaranteed lending schemes
These types of schemes vary according to economic conditions. For example, during the COVID-19 pandemic, many government lending schemes were initiated to support small businesses who faced financial difficulties, but many of these schemes have now closed.
The Recovery Loan Scheme is still open until June 2022, and provides term loans, overdrafts, invoices or asset finance up to a certain amount. It can only be accessed by SMEs, and the maximum amount available to a business is £2 million. You can find a lender here.
Friends and family
Instead of approaching a banker, you could ask family or friends for funding – if they have it. If you can consider this option, seeking capital from those close to you has many benefits: it can be easier to manage your debts, the funding may be interest free, and there would be some flexibility.
However, if expectations, repayments, shares, and ownership are not discussed and negotiated properly, there is potential for relationships to turn sour.
Venture capitalists (VCs) invest capital into early-stage companies to encourage them to grow into a successful business. Likewise, VCs have expert financial knowledge, and usually offer these companies strategic advice. There are different stages in VC investments. Namely seed, start-up, early stage, late stage, and expansion.
To raise funding for your business, you can sell shares to an investor or existing shareholders. Angel investors and venture capitalists use equity finance to fund businesses. While equity finance investors will claim some of your future earnings, you usually don’t have to pay interest on the capital.
You can use Swoop to find an equity finance investor that will suit your needs.
Of course, there is always the option to invest your own personal savings into the acquisition. This is the most cost-effective and safest option, as you won’t be required to pay back any debt. However, if you do not have all the capital saved up, you can always combine your savings with another form of funding.
Finally, you can approach almost any bank to secure funding to buy a business. There are many advantages of applying for bank loans:
- Term loans don’t need to be repaid immediately
- You don’t need to give up shares or profit of your company
- Depending on your financial history, you can receive relatively low interest rates
- With the right research and financial responsibility, they can be easily managed
However, there are disadvantages of loans which you should be aware of:
- Large loans will have strict conditions you need to adhere to
- If you experience cashflow problems once your business is up and running, this can severely impact your repayment structure
- If you apply for a secured loan, you can lose your home or other assets you put up for security
- You can get charged if you attempt to repay the loan before the end of its term
It is your responsibility to evaluate your financial position and decide if you can manage a loan. You can explore hundreds of UK banks that offer loans.
Kickstart Your Purchasing Journey
Buying a business is an exciting venture and growing it to new heights is a significant achievement. Not every individual has large sums of money to do this, so there are multiple funding options available to you.
It is crucial that you conduct your own research after reading this guide and ensure that your decision is informed and suits your unique financial position and abilities.
We encourage you to put your best foot forward and wish you every success in your purchase. There has never been a better time for a new beginning!
If you’d like more support, or you would like to talk to someone from the team, feel free to contact us.
If you’d like to speak to a finance provider, BusinessesForSale.com can connect you with ASC Finance.