As a business broker I often receive enquiries from interested buyers with great ambition, drive and desire to buy a business- but with little funds available.
In the process of concluding the NDA the questionnaire requires the enquirer to indicate how much cash resources they have available as well as the amount of collateral (assets) the prospective buyer have which can be offered as security to a financial institution. Both are extremely important variables for both sellers and financiers that will establish what the relative chance on successfully obtaining the funding will be.
This is the amount of cash that the prospective seller has available which is not already borrowed in the form of a bond or other encumbrance. The cash available is extremely important as this becomes the portion of the transaction value that establish the equity portion that the Purchaser will hold in the total transaction value.
If you, for example, have R100,000 in cash available and is interested in acquiring a R1,0m business it means you need to borrow 90% of the funds required and would be expressed as a 90% debt to equity ratio or also referred to as the gearing ratio.
This represents the amount of assets that you have available to offer to a financial institution as security against loans that you are making in the process of acquiring a business. The financial institution will view liquid assets (something like shares or bonds) more favourably than relatively illiquid assets and almost completely ignore the value of illiquid assets such as furniture, fittings and specialised machinery.
Collateral does not affect the gearing ratio but is very important for the financial institution in order to minimise the risks associated with the transaction.
The Financial institution of your choice will also consider the assets of the business you acquire but, in addition to the personal assets you have, will apply a value factor to these assets depending on the perceived liquidity of the assets.
In this action lies the big conundrum in that they would favour high asset value acquisitions (lots of machinery and fixed assets). Businesses that operate with large fixed assets and large quantity of working capital (stock & debtors) will always require more and more capital as the company grow and expand. Businesses with little assets can double and redouble without the requirement of further cash injections. Companies that require large fixed capital assets also have ongoing expenses to maintain these assets in good condition. Businesses with large working capital have additional risks in the form of stock losses and redundancies as well as losses from unpaid debtors.
Understanding the financial institution you approach for funding simply means being able to empathise with their decision-making process they follow. They receive dozens of applications for every single one they eventually finance. The following 4 factors are essentially the most important although not exclusive to the process:
Gearing ratio: as previously explained, this is defined as the degree of funding compared to the own cash contribution. Having less than 30% own contribution makes the process a near impossibility. The same rules apply even for businesses on the stock exchange. Have a gearing ratio in excess of 70% would expose the business to extremely high debt levels which eventually becomes a debt trap resulting in enormous risks to the financier. I believe for your own good you should never consider gearing the business by more than 50%. This means that you should have R500,000 of every R1,0m of the total purchase consideration.
Security: This is where the collateral comes in. The sum of personal and assets included in the purchase price. The current assets or working capital is normally not included in this calculation as stock, cash and debtors are all liquid and can be there the one day and gone the next. This offers little security against unpaid loans. If you have 50% of the purchase price in cash and can offer collateral for the other 50% the chances of securing the finance is very high. Remember that you compete with all the other applicants and the one with the lowest gearing requirement and lowest risk WILL ALWAYS be favoured.
The Business: The business, its operations, profitability, history and sustained future are all important factors in securing finance. Most small businesses have very weak and unreliable financial records and will not qualify for funding AT ALL. It is now becoming important in your business selection process that you do not only consider if YOU like the business and what it does but also have to consider the view of the financial institution!
The applicant: In addition to the financial institution’s interest in your financial position from both a cash and collateral contribution point of view they would also be critically interested in your skills and experience in business and even more specifically in relation to the business you are planning to buy.
It is extremely difficult to obtain financing for the acquisition of a business. You will be properly tested during the process of applying and it takes many months of hard work before achieving success.
A relatively low own cash contribution (high gearing ratio) will require a whole lot of other factors to compensate. These factors include collateral which reduces the risk on the financial institution, business contributions such as a solid profit history and sustained growth possibilities. Finally, your own business experience, your credit record and specifically paying back previous loans and business loans. Qualifications and experience and even more importantly relevant qualifications and experience of the business you are acquiring.
Most sellers are not interested to interview prospective buyers with a low probability of securing the necessary funding. It is almost in every case very difficult for a seller to open up and expose the business as this process is always required to be highly discreet with as little disruption to the operation, staff, customers and other stakeholders.
It is generally expected from prospective buyers to reflect accurate information and it can go a long way in securing an interview if the purchaser proactively prepares a CV or document that can strengthen their chance on success. The buyer can never go the financing process alone and will lean heavily on the support of the seller.
“but I have someone that will back me”
I get this at least once a week that someone has no own contribution, but he has a relative or friend that promised to put money behind the action. In most cases I have witnessed over the years this came to nothing. It was merely a hollow offer with the backer withdrawing at a later stage.
The only way to deal with such a scenario is to involve the “investor or backer” from day one. This person is the byer and you are going to manage the business for him once he has acquired it. You should ideally sit down with this person and form the agreement that guides your relationship before you start looking for businesses you wish to view.
This process includes: the creation of a new company with shareholders agreement between you and the investor. Employment agreements between you and the investor to establish who is going to do what in return for defined remuneration.