Barackoli.com - Business Talk

Once this determination is made, and depending on your credit rating and how motivated the seller (or vendor) is, you may wish to try and obtain financing from the bank where the business is conducting it’s business.  The reason for this is quite simple, they have an idea of what the annual deposits are, a history of the business (at least with their institution), and a sense of how valuable the business is to them. If they consider the business of value, they’re going to make an attempt to retain this business.

As such, a business which is largely valued on it’s tangible asset, may be able to use these assets as security for the loan to partially finance the business.  And if the Seller is motivated, he/she may accept payment terms for much of the difference between what the bank will lend on these fixed assets and what the Seller is asking.   This is not an uncommon practice.

If you’re attempting to secure a relatively large amount of money and/or your credit rating is somewhat suspect, this is where a business plan can become beneficial since it allows the bank to evaluate your business skills on a professional level.

If this approach is unsuccessful, for whatever reason, you may still attempt to obtain financing for a business purchase through a government program. This program, which is government sponsored, allows for financing of up to $250,000 and is secured by the fixed assets or  leasehold improvements of the business.  It can not be used to secure financing for goodwill.

But what if the business doesn’t have much value in terms of tangible assets? Many businesses such as a professional practice, value their businesses largely in terms of their gross revenues, how should these be financed?

Well in general terms, these types of businesses are often vendor financed.  The reason being is that when a vendor sells a business, he/she warrants that a certain amount of revenues is ongoing.  But how can the purchaser determine the validity of this claim? and how do you account for those clients who move, become deceased, were never ongoing clients to begin with? or object to doing business with the purchaser for whatever reason?

In this situation, there is only two ways of valuing a business with these amount of unknown variables. One is to discount the price of the business based on some estimate of what percentage of the business is likely to fall into one of the above categories, and thus not be reoccurring,  or to pay a vendor in hindsight once these issues have been determined.

If you decide to discount the price of the business and estimate the percentage of clients who will not retain the services of the purchaser, one of the two parties is likely to be shortchanged.  The reason being is that he probability of being able to predict this percentage is extremely low.

So most opt for the method of paying in hindsight, this is usually consists of paying the vendor a percentage of the gross collectable revenues over a number of years.  For example, under a four year payment schedule, the formula might be 25% of the gross collectable revenues per year.  Although, in practice, this method often is front ended to put the onus on the purchaser to retain these clients over time.  To compensate the vendor for financing the business an interest calculation may also be included to reflect that the vendor is forgoing the opportunity cost of investing these funds.

The bottom line is that purchasing a business can often be complex and creative approaches can go a long way to ensure that financing a business purchase can take place.

With respect to additional financing which may be required, one of the least expensive methods in terms of interest rates is to secure a line of credit with an asset such as a home and remember, the interest on this loan is likely tax deductible.