Articles
Financing Businesses
by Scott Balfour

One of the biggest challenges to buyers acquiring and sellers selling a business is obtaining financing. One of the reasons it is so challenging is that there is not a universal set of underwriting guidelines like there is in other types of lending:

For a credit card you simply apply, then based on the credit score from the credit agencies and your income level, a card will be issued w/ a pre-set rate and limit.

For larger purchases like an automobile, it is also based on your credit score, the values of the car and perhaps to your current employment income.

For a residence it is based on appraisal of the home, credit score/history, and ratios based on your employment income and debt.

For Investment Real Estate the amount of the loan is usually based as a percentage (75 to 80) of the building being purchased appraised value and the cash flow from the building. It assumes a good credit history of the purchaser, but is not dependent on the employment income of the buyer.

For businesses there are just too many factors to be considered. Some of these factors are: The assets of the business: are they furniture, fixtures and equipment, inventory, rolling stock, receivables? The business trending, up or down. The credit history of the buyer. The amount of goodwill. The work experience of the buyer. The financials of the business being purchased. The structure of the sale, stock or just assets. Does the business lease or include real estate? The industry, the business in etc. Add to that that each lender has its own in-house set of guidelines. Banks using programs with-in programs, like the SBA all have their sets of rules.

Ok, enough about the problems….how do you get financing for small businesses?

From a purchasers point of view the first thing you should do is assemble; a copy of your credit report, complete a detailed personal financial statement, dust off and revise your résumé, and collect your last three years tax returns.

From a sellers point of view you need to assemble: a list of Furniture, Fixtures and Equipment, get a handle on your inventory value, a copy or your lease or deed and mortgage note if the real estate is included, A financial statement of the business, the last three tax returns for the business and a year to date income statement, create a description and history of your business, its markets, employees, venders, customers, processes, etc.

Now here is what is interesting. The ultimate financing will be based on a combination of the strength and weaknesses of both the purchaser and the business being purchased.
This is why without knowing both sides there is no simple answer to “What is typical financing for a business”?

Now let’s look through this pile of papers. Let’s start getting some answers to some basic questions:

DOWN PAYMENT: How much cash is available from the purchaser? What assets of the purchaser can quickly be converted to cash? What assets could be pledged for security? Are there any ‘angle’ investors, family friends, etc? Now that we have how much is available lets look at what is required. What is the price of the business? What are the assets of the business?
Itemize them into broad categories like, inventory, equipment, machinery, receivables, real estate, goodwill. Lenders often require a pre-set down payment that varies on each category. After this is all said and done if you have between 20% and 50% for a down payment, proceed. If not, it still could happen, but you are outside of the normal box, and it won’t be easy.

CASH FLOW: What is the constant and predicted cash flow of the business? Subtract what you as owner feel you need to take home as a reasonable salary. Take the remainder multiple it by 75%. This will put you in the ballpark for what is referred to as ‘available for debt service’. Take the available for debt service number, apply prevailing interest rates and appropriate terms for the loan or loans. Do the calculations. You will then have an amount that can possibly be financed.

If the amount for possible financing and the available down payment is greater than the businesses purchase price, you’re good to go. Not everyone will be interested in lending for a variety or reasons. Shop around. Financing may have to come from a variety or sources, including the seller. In a future article we will go further into ‘sources of financing’. But at least for now you have a good starting point.

So in summary, business financing is based on the interplay of the 4 C’s. Credit of purchaser, Crictor of purchaser (résumé) Collateral, and Cash Flow of the business.

We at Magnusson Balfour take great pride in our ability to match ‘buyers, businesses, and banks’. Do let us know if we can help you.

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