Funding to buy an established business

What does acquisition funding cover?

Buying an established SME rarely comes down to a single number. The agreement for sale and purchase usually splits the price between goodwill, plant and equipment and stock at valuation on the settlement date. On top of that the buyer needs cash for legal and accounting costs, any lease assignment requirements and, most importantly, working capital to run the business from the first Monday.

Acquisition funding can cover any mix of:

• the shortfall between your cash contribution and the purchase price
• stock, which is often only confirmed at a count the day before settlement
• working capital for the first months, while you learn the customers’ payment habits
• paying out equipment finance that the vendor must clear before settlement

Why is buying an existing business funded differently?

Banks often find SME acquisitions awkward. A large part of what you are paying for is goodwill, which a lender cannot sell if things go wrong. Business plans are built on someone else’s track record, and the buyer may be new to the industry.

The practical answer for many New Zealand buyers is to secure the funding on property they already own, such as the family home, a rental or a commercial building. That changes the lender’s question from “what is the goodwill worth” to “is there enough equity and does the deal make sense”. A first or second mortgage is possible, even when there is already a mortgage on the property.

How do you know the price is right?

Funding is only half the job. Before the finance condition expires you should be confident about what you are buying. Our guides cover this in depth:

• How to value a small business before you buy explains earnings multiples, owner’s wages adjustments and why the vendor’s add-backs deserve scrutiny.
• The due diligence checklist lists what to request, from GST returns and IRD statements to the lease, key contracts and a PPSR search.
• Earn-outs and deferred consideration covers deals where part of the price depends on future performance.

Business.govt.nz also recommends appointing an accountant and lawyer early and checking the vendor’s reasons for selling against the financial records.

What does a lender want to see from a buyer?

For a property-secured acquisition loan, no financials or tax returns are needed for the initial assessment. As the deal progresses, expect a lender to ask for:

1. The signed agreement for sale and purchase and its conditions.
2. Details of the property offered as security and any existing mortgage.
3. A summary of the business being purchased: what it does, how long it has traded, headline turnover.
4. Your own experience, or the experience of the manager who will run it.
5. How much of your own money is going in.

Bad credit, defaults and arrears are considered case by case. A past problem is not automatically a barrier when the security and the deal stack up.

Example scenario

Example scenario, generic and for illustration only. A couple in the Bay of Plenty agree to buy an established engineering workshop with six staff. The price includes goodwill, a yard of plant and stock. Their bank is slow to respond to the goodwill component and the finance condition is ten working days away. They enquire, a lending specialist arranges a second mortgage over their rental property to cover the shortfall and opening working capital, and the purchase settles on time. They later refinance to a longer-term arrangement once the business has a year of trading under their ownership.

What happens after settlement?

The first year of ownership is where acquisitions succeed or struggle. Keep a close eye on debtors, since customers sometimes test a new owner’s collection habits. Consider whether some of the facility should be kept available for working capital. And plan the path from short to medium term acquisition funding to your long-term structure, which our guide on when to refinance covers.