What Is a Business Loan?
With their sights set on being a successful business owner and owning a profitable business, many South African entrepreneurs have ambitious business goals. One method in which these goals and aspirations can be reached is by buying a business that already exists.
However, purchasing an entire business costs a lot of money – which most individuals don’t have. So how can you achieve your dream of owning your own business?
A business loan is a set amount of capital which is received by a prospective business owner in order to purchase an existing business. Business loans are offered by a variety of different financial institutions, such as banks, private firms, and peer-based loaning structured platforms.
As we’ll discuss in this guide, there are many different types of business loan options in South Africa, with an equally great amount of business loan providers.
Find out more: Thinking of buying a business? Read our guide on how to buy a business for helpful tips.
Why You Should Buy a Business Instead of Starting One
Although starting a business has its own unique pros and cons, buying a business usually has greater advantages.
One of the most notable advantages of buying a business is that existing businesses already have a substantially sized customer base. This results in the new owner of the existing business spending much less on customer acquisition and marketing costs compared to starting a new business with no customer base.
A loyal customer base will also result in repeat business, word-of-mouth advertising, and the opportunity for the business to increase their prices, resulting in increased profitability.
When starting a new business, the business will need to spend substantial amounts of capital and time on marketing and customer-acquisition strategies so that they can start building-up a customer base.
Another considerable advantage of buying a business is the fact that an existing business already has employees who are knowledgeable of how the business operates. This means that as the new business owner, you can get started with operating your new business from day one. However, when starting a new business, you will need to spend time and money on recruiting employees, as well as spending time and money on training these new hires on how you would like the business to operate.
Whether you are a motivated and dedicated entrepreneur looking to purchase an existing business, or whether you are looking to invest in a franchise, BusinessesForSale.com offers South African entrepreneurs the unique opportunity to explore thousands of businesses and franchises in different sectors. These often already have existing customers, business structures and products and services, and most importantly, an established cash flow.
The MergerVault division of BusinessesForSale.com offers qualified buyers the opportunity to purchase verified and high value businesses situated in South Africa. Interested buyers will need to complete the Investor Verification Process and also sign a Buyer Consent Form. Vetted buyers will have the opportunity to either purchase or merge with a verified high value and profitable business.
Find out more: Want to know more about the buy-side of M&A? Understand the buyer’s perspective in mergers and acquisitions.
The Importance of Valuing a Business Before the Loan Application
There are two necessities related to evaluating a business before taking out a loan. First, many lenders require that the borrower representing a business submits different financial documents.
This serves the purpose of enabling the lender to evaluate and assess the likelihood of the business paying back the loan, as well as to calculate what the interest rate should be.
Amongst these financial documents, a vital document which must be included is the professional evaluation of the business. A strong evaluation of a business will make lenders feel more comfortable about providing the business with a loan, and it could also result in a lower interest.
Secondly, business valuation is necessary before taking out a loan so that you, as a small business owner, have an understanding of the value of your business and the estimated business loan terms and conditions which might be offered to you.
After evaluating your business, you may come to the conclusion that getting a loan may not be the best option. This is especially true if a business with a relatively low valuation would like to get a loan which is of a relatively high amount.
ValueRight is an online tool which allows users to value their business free of charge. With the assistance of information that is submitted by the user, ValueRight is able to provide an accurate, fast, and practical valuation for any type of business. This tool takes out the stressful and time-consuming act of small business administration, and allows small business owners to focus on securing a loan and growing their business.
In addition to ValueRight, you can explore our guide on the different steps that may be taken to value your business. This article covers all the necessary requirements when valuing a business, and includes valuation examples, tips and advice, and different valuation techniques.
Points to Remember Before You Consider Funding Options
Understanding your market
The market and industry that you operate in has different suppliers and stakeholders related to different aspects of your business. For example, small businesses operating in the motor industry will deal with different suppliers and stakeholders than a business operating in the restaurant industry.
A business that needs to purchase equipment may find that a term loan is the best option for them, whilst a business that believes leasing equipment is the best option for them may find that a hire purchase agreement is the best financial option for them.
South African business owners should seek to make use of market specific financing. In all major industries in South Africa, you can find a certified business financing provider that specifically deals with the market or industry in question. These financing providers understand the market that they operate in and will therefore be able to give you the most efficient and sustainable financing quote.
Sufficient down payment
A lender may require that a borrower pays a down payment when taking out a business loan. This down payment reduces the lending risk associated with the lender, i.e., if a borrower is unable to pay off their loan, then the lender will be partially covered with the down payment received when the loan was taken out. The financial amount of a down payment required will vary from one loan to another, but usually this amount is determined by the borrower’s credit history and collateral put up for the loan.
Funds to pay for interest rates
Business loans are required to be paid back to the lender with interest. For example, if a business takes out a loan for R500,000, they will be required to pay back the R500,000, as well as an additional percentage of this sum on a frequent basis, i.e. the interest rate per month.
This results in the lender receiving constant financial receivables. Interest rates will vary from one loan to another. Factors which affect the calculation of an interest rate on a business loan include the business’s profitability, cash flow, type of business, the business owner’s credit score, and the loan amount requested.
A business must ensure that the they either have existing funds to pay in the future for the interest rate of their loan, or they must have a set-out plan in which the business is going to generate enough revenue in the future to pay off the loan and it’s interest.
Your debt-to-income ratio compares how much you earn (income) a month with how much you spend on monthly payments. An individual’s debt-to-income ratio is one of the main elements that financiers take into consideration when determining whether they would be able to offer you financing options.
Borrowers with lower debt-to-income ratios are more likely to be offered favourable financing terms and conditions than that of borrowers with higher debt-to-income ratios. This is because a low debt-to-income ratio represents an individual’s ability to pay their debts consistently on time on a monthly basis.
The following method is widely used to calculate debt-to-income ratios:
- Add up all the different debts that you owe for a month (house rental, student loan, mortgage, etc).
- Determine what your income for the same month is.
- Divide your debt by your income.
- Multiply this figure by 100 to arrive at a percentage.
For example, suppose that John owes the following for the month of March:
- Credit card – R10,000
- House rental - R15, 000
- Car loan – R20,000
- Student loan – R5,000.
When you add all of these figures together, you get a grand total of R50,000. Now suppose that John has an income of R70,000 for the same month.
In order to calculate this John’s debt-to-income ratio, the following formula will be used:
(50 000/70 000) x 100
From the calculations above, John will have a relatively high debt-to-income ratio of 71.43.
Suppose that another individual, David, owes the following for the month of March:
- Credit card – R7,000
- House rental – R10,000
- Car loan – R10,000
- Student Loan – R0.
When you add all of these figures together, you get a grand total of R27,000. David also has an income of R85,000 for the same month.
In order to calculate David’s debt-to-income ratio, the following formula will be used:
(27 000/85 000) x 100
From the calculations above, the David will have a relatively low debt-to-income ratio of 31.76.
Since David has a considerably lower debt-to-income ratio than John does, lenders will offer better financing terms and conditions and be more confident in providing financing to David rather than to John. This will more than likely include relatively low interest rates for David compared to John.
Cash reserves to pay closing costs
Closing costs are the fees and expenses paid by a buyer and seller when a financial deal has been closed. Closing costs are mostly seen during house mortgage deals. A lender may require that the borrower has existing cash reserves of a certain amount or for a certain period of time.
For example, a lender may require that a borrower has perhaps a 5% (of the final deal value) sum of cash reserves for a period of 4 months. Borrowers must therefore ensure that they have this amount of cash reserves before they close a deal.
Business plan considerations
Lenders want to see that a business has a strong plan to make use of the financing that they are requesting, and that the business has a clear pathway revolving around their desired financial goals.
The most efficient and professional manner in which to convey this to a lender is through a concisely prepared business plan. A business plan allows lenders to understand the actions that a business is planning to take to achieve their objectives. Developing a strong business plan greatly increases your chances of securing a business loan, and some the key contents of a strong business plan include marketing strategy, financial planning and forecasts, tax returns, the products or services offered by the business, and the assessment of the market the business operates in.
Negotiating finance terms that suit you
It is a common and acceptable practice to negotiate the terms and conditions of a loan with a financial services provider. The following tips may assist you to negotiate the best finance terms and conditions:
- Know your budget – By establishing and knowing what your budget is for a specific loan, you will be able to efficiently negotiate terms and conditions which align with your budget.
- Pay cash – Many lenders offer a discount and/or favourable terms and conditions if the borrower is paying them exclusively with cash. If you have access to large sums of cash, this strategy may be a simple and effective method of negotiating finance terms.
- Compare quotes – By shopping around and receiving quotes from different institutions, not only will you be able to compare which quote is the best for you, but you will also be able provide concrete evidence to lenders of existing quotes you have received.
- Know financial terminologies – By understanding the different financial terminologies that financial institutions usually use, you will be able to better understand the exact terms and conditions being offered. This will allow you to negotiate these terms and conditions.
- Develop a negotiation strategy in advance – Developing a negotiation strategy before you actually negotiate with a lender will enable you to follow a thought-through and planned strategy of negotiation.
Acceptable credit score in South Africa
All South African credit scores will range from 0-999, with 0 being the lowest possible credit score one can receive, and 999 being the highest possible credit score.
The majority of banks and other lenders in South Africa require that an individual has a credit score of at least 600 when applying for financial assistance. However, this score of 600 is seen as a bare minimum, and banks and lenders will most likely only take your application seriously if you have a credit score of at least 650.
Other than getting assistance at a local bank to check what your current credit score is, there also exist online tools which help you understand your credit scores. Experian is a leading credit score provider. Through the input of information by a user, Experian is able to provide an accurate and fast credit score number to its users.
Types of Funding You Can Explore
Quick Consolidation Loans provides unsecured loans to individuals residing in the Gauteng province. In order to be eligible and obtain this loan, the first requirement is that you receive a stable monthly income. If you meet this requirement, you can then apply for an unsecured loan online, and Quick Consolidation Loans will get back to you with more information.
FinYou Commercial Finance has a simple online application form where Gauteng residents can apply for commercial mortgages. There are a series of business related questions that applicants need to answer.
As a leading asset financing business in Gauteng, Asset Finance Corporation offers ‘access to movable assets without the disadvantage of depleting your cash flow’. When applying for asset financing, some of the information that will need to be submitted include insurance information as well as trade references.
Based in Johannesburg, Mutualism has the goal of empowering entrepreneurs through affordable asset-based financing. Further details about their funding process can be found here; and online applications can be made here (you will need to create an account or download their app).
One of the services that the Gauteng Enterprise Propeller offers is a combination loan. To obtain this type of funding, applications can be made online. Please ensure that you state in the application form that you are applying for a combination loan.
In order to request more information and a loan application form from BTS Finance, you will need to submit an online form which includes your personal details such as your name and contact details.
You can follow this link to apply for asset-based lending at Lamna Financial.
Combination loans in the Western Cape can be found at Combined Finance, and online applications can be found on the home page of their website.
Challenor Finance offers unsecured loans to residents of KwaZulu-Natal. Different documentation needs to be submitted online to apply for a loan.
Custom Capital is an asset-based finance company. Their specific fields of expertise include the commercial vehicles and point of sale equipment. Please contact the company for details on how to apply for asset financing.
Market Direct provides unsecured loans within the Limpopo province. The online application form can be found on the home page of their website. You will need to submit your business’s gross and net income.
Land Bank specifically provides commercial mortgages to businesses in farming industry, the majority of which are based in Limpopo. For more information on the services provided by Land Bank, please contact them here.
You can apply for asset-based lending at Capital Hunting.
Applications for SKG Home Loans can be made on their website.
The application form for Blue Chip Finance can be found on the home page of their website.
With offices based in Bloemfontein, Better Bond offers commercial mortgages.
Spartan offers multiple funding options for SMEs looking to grow and prosper.
Tsembeka Finance, based in Nelspruit, offers asset finance. If you’d like to discuss finance options, you can call them on the number listed on their website.
While Letsatsi Finance does not have a North West branch, they can still help you apply for a loan if you live in other provinces.
DirectAxis offers asset-based lending for different industries. Applications can be made on the home page of their website.
Royal Finance offers residents of the Northern Cape unsecured loans.
Other Sources of Funding that Might Interest You
Angel Investors provide both financing and mentorship to early-stage businesses. In exchange for this financing and mentorship, angel investors usually receive a portion of the business’s equity. Some options available to you are:
A business grant can be awarded to a business who makes a difference in their community or has business expansion plans. Business grants are usually provided free of charge by Government institutions, NGOs, or private organisations. Business grants may not be the best funding option to purchase a business, but they can certainly help expand, develop and grow components of your business.
If you’d like to explore multiple business grants in South Africa, please read our grants guide.
Government-guaranteed lending scheme
A government-guaranteed lending scheme is a national program initiated and run by the local Government. Under this scheme, the local Government works together with other financial service providers (mainly banks) to offer relief to citizens in the form of financial assistance.
An example of such a scheme in South Africa is the Covid-19 Loan Scheme, in which banks gave financial relief to the public in the form of a six month re-payment holiday and other gestures.
Friends and family
If they can, your own friends and family may be willing to fund your business ventures. Often times, friends and family may provide you with financial support for your business with no strings attached. However, it may be a good idea to offer a friend or family member equity in your business, or a free product or service offering from your business.
A venture capitalist (VC)is either a private individual or group of individuals who come together with the aim of investing in high-potential and attractive businesses and start-ups. Venture capitalists provide certain amounts of agreed upon capital to businesses in exchange for equity, and usually also provide business advice. Some VCs you can explore are:
- Kalon Venture Partners
- Hitch Innovation Group
- Cloupcap Ventures
- Laurium Capital
- Hlayisani Capital
- Geyser Enterprise Development Group
Equity financing takes place when a business sells a percentage of their shares or equity in exchange for capital. For example, a business may decide to sell 10% of their business for R100,000. This equity may be sold to a group of different investors. Some organisations you can explore include:
- Future Growth
- Caban Investments
- Enygma Ventures
- Khula Lula
- Rising Tide Africa
- Digital Africa Ventures
- Founders Factory Africa
- Knife Capital
Your own funds
If you have access to capital of your own – like a savings account, then funding a business with your own funds may be a suitable option. If you already own the capital that is being invested, you will not need to adhere to any terms and conditions, like interest on a loan or giving away equity from your business.
Banks will always have access to large sums of capital and will therefore be able to offer a wide range of funding solutions catered to your needs. Bankers may also provide riskier lines of credit which other smaller lenders may not be comfortable providing.
The main banks within South Africa include:
Pursuing Your Buying Journey
Business loans provide a lifeline to aspiring business owners who do not have the financial means to purchase a business.
With the ever increasing costs of living and monthly expenses for the average individual, business loans are becoming a more and more popular tool of financing.
Additionally, financial service providers are developing new and unique financing options which cater to different markets and demographics.
We wish you the best of luck on your purchasing journey. If you’d like more help or information regarding business acquisition financing, you can contact our team.