Are you thinking about taking a loan to secure a business? Prepare yourself for the process with this FAQ.
Buying a business can require a lot of money, which is why many people consider taking out a loan to ease the burden.
But in order to make this option work for you, not only will you need to fulfil a number of lender requirements, you’ll also want to make sure you’ve planned out exactly how taking out a loan will benefit you in the long term.
Here’s a list of common questions on the matter and their answers to help you prepare.
What is a business loan?
A business loan is a sum of money that is lent to your business and requires you to repay the loan, with interest, within an agreed time.
A loan can give your business a boost, help manage your cashflow or help you grow if you’re looking to expand, Commonwealth Bank general manager, business lending, Sam Hemphill said.
“The process for applying for business finance varies between different products, and you may be asked to provide financial statements, identification and a few extra documents if you are a startup business,” said Hemphill.
Who offers business loans?
A range of financial providers offer business loans aside from banks, so it’s important to shop around.
Consider and compare loans from credit unions or one of the emerging fintechs on the market.
READ: New solution to make access to working capital simpler
What should I prepare before talking to a lender?
In order to borrow a useful amount of money without getting into in an untenable situation, you need to assure a lender you can purchase the business and make it profitable.
Here’s what you should consider preparing before starting the conversation around which loan apply for.
1. Business background
Lenders will want to understand your professional background, your plan with the business, as well as how and when you’ll achieve profitability.
2. Borrowing needs
To start with, work out how much money you need to borrow to both purchase the business and perhaps some initial working capital as you get your feet on the ground.
The key here is to be realistic — you’ll need clarity on the key figures in terms of what you need and what you can achieve with the additional funding in order to service the loan.
3. Financial records
Financial statements from the current owner will be required, complete with financial projections to highlight whether you expect to be financially viable in six months, a year, or more. You will also need a carefully articulated business budget.
Lenders will require the financial statements for the last two years of the business you want to buy, chief growth officer of Valiant Finance, Tsing Lee recently told The Pulse.
This includes the asset and liability statement, a profit and loss statement, tax returns and potentially bank statements.
“If the incoming directors currently own any other ventures or businesses, these businesses may also fall under the same scrutiny to support the loan application,” said Lee.
4. Capital investment plans
You will also need to give the lenders a breakdown of how the loan will be spent which helps them to understand when they can expect a return on investment.
5. Advisor relationships
The lender will make a decision based on this information, so making sure it’s been carefully prepared (preferably with the help of an accountant) could be what seals the deal.
Bear in mind that how long it takes to be approved varies, so be sure to get the ball rolling sooner rather than later.
Does my credit score matter?
Yes, your personal credit score matters, and may even influence the interest rate offered to you by a lender.
Depending on which credit reporting agency you use, your score will appear as a number on a scale. An excellent score is usually between 800 and 1000, while a below-average score is about 550.
It’s worth noting that there’s been some changes in what you’ll see on your credit report. Up until July 2018, only negative financial behaviour was recorded.
But now, financial institutions add positive financial behaviour too — such as paying out a loan early.
This extra detail gives lenders an even clearer picture of your financial habits when determining whether you’re good for a loan.
You can access your credit report for free online via Equifax, Illion, Experian Credit Services or Get Credit Score.
Why does my lender want to see a business plan?
The most important document is the business plan, detailing what you’re going to achieve to validate the structure of the business.
But the exact amount of detail a bank wants may vary on a case-by-case basis across industries, NAB business bank executive Adam Zaccaria explained.
“What we’re really interested in is what the customer strategy is, what they want to change in the business, and what fundamental problems they want to solve,” said Zaccaria.
Having a business plan and the financials prepared or at least validated by an accountant is viewed favourably by banks, depending on the competency of the owner to complete on their own.
“The key to any business is to plan well and execute on that plan,” he said.
Make sure you do your due diligence when purchasing an existing business.
If you’re asked a question during the loan application process and you don’t know the answer, it won’t bode well for you.
You also need to understand why the seller wants to exit the business, and whether perhaps they know something they haven’t mentioned, such as new competition entering the market.
How much of a deposit can I expect to provide?
Lenders may also ask for a deposit to see your personal commitment to the business.
The size of the deposit varies, but lenders could be looking for a deposit of between 10 and 30 percent.
What type of loans are best for buying a business with?
Make sure you take the time to consider what type of loan works best for you, Hemphill said.
“There are number of different options between the types of loans (such as a term loan, equipment loan or an overdraft), the interest types (fixed or variable) and the repayment types (interest only, principal and interest or a combination of both),” he said.
The most suitable loan type depends on your business needs, length of the loan and the sum of money you need to borrow, Hemphill says.
“If you’re looking to grow or expand your business, a term loan allows you to cover larger up-front costs and provides a lump sum payment in order for you to finance your investment.
“If you’re looking to purchase an asset for your business like a car or machinery, an equipment loan allows your business to purchase an asset from a supplier and pay back the bank over a set term.”
How much should I borrow?
Calculating how much to apply for needs careful consideration.
Hemphill says new business owners need to bear in mind when purchasing a business, there could be significant up-front costs including the business purchase price, rent, equipment, additional shop fit-outs, inventory and wages.
“Businesses usually secure debt finance from a bank in order to cover the up-front costs when purchasing a business.
“A term loan is the most common type of debt finance used to finance the purchase of a business, as term loans allow you to repay the loan with interest over the medium to longer term, while keeping your repayments lower to help manage cash-flow,” said Hemphill.
With a term loan, your payback period can range depending on the type of security used to guarantee the loan.
“You can also pay principal and interest to completely pay down the loan at the end of the loan term, interest-only to pay only the interest component during the term with a lump sum payment at completion, or a combination of both.”
Consider getting professional advice from your accountant or a business advisor.
How do lenders decide whether to approve my business loan?
Lenders still predominantly use a decision methodology to assess risk and whether that risk falls within pre-defined, acceptable margins, said Lee.
These are:
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Character – willingness to repay
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Capacity – ability to pay back debt
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Capital – size of deposit and how much saved
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Collateral – assets as security for the loan
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Conditions – market conditions
The lender will look at how long the business has been established and trading for, how many employees they have, and the background and experience of incoming directors to better understand the risk posed by the change in management.
“If you’re looking for working capital, your borrowing power revolves around your business’ cashflow in the last 12 months.
“However, not all lenders are created equal and some will be more lenient.
“If your last six months have been great but your last 12 paints a less rosy picture, it’s crucial to know this to yield the best result possible,” said Lee.
A compelling credit submission that explains the purpose of the loan and how the risks are mitigated will help you get a better outcome.
“Lenders will assess the overall profile and determine the risk that they are willing to take depending on the asset type and condition plus the business’s overall credit worthiness and business performance.
“Sometimes, even though you do own a property, contributing a down payment can get you better terms, such as a lower rate.”
Buying a new business is both an exciting and sometimes stressful time, we can assist in evaluating your new business and your finance requirements, to get you started with your best foot forward Call us on (03) 9769 9500 today.
Source: MYOB December 2021
Reproduced with the permission of MYOB. This article by Nina Hendy was originally published at https://www.myob.com/au/blog/loan-to-buy-a-business/
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