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Raising Finance to Buy a Business

Raising finance for a business purchase isn't easy, but there may be more options than you think.

Once you have decided on the kind of business you want to buy - whether it's a restaurant, a pub, a hotel or even a game park, you will need to address the all-important issue of financing your purchase.

Few people have the means to buy a business with cash without the need to borrow. This is the same for all buyers - whether they're acquiring a coffee shop in Grahamstown or a million-rand software company in Johannesburg.

Using a bank

Unsurprisingly, banks are the most common form of external finance for small businesses - and this will be the same for you.

You should approach the bank that you already deal with and see what they suggest as the best option for you.

Banks are generally very risk adverse and so that will want to loan money to businesses that can prove that they will be capable of repaying the money.

In order to be successful, you must make a coherent case for borrowing the money as banks have strict lending criteria. You will often be required to show the following information:

About the business

Accounts

You will need to supply audited accounts for the business you intend to buy, for the last three years where possible. Make sure that these accounts are a true reflection of the business. A bank can only lend money to you based on these accounts, regardless of any hidden income that an owner may assure you of.

Revenue projections

This has to be a realistic revenue forecast for the business. You can even create two or three scenarios to give the bank comfort on the likelihood of different outcomes. You must also detail what your cash flow is going to look like after you have factored in costs - such as repayments of the loan you are taking out.

Business plan

This doesn't have to be an exhaustive 50-page plan, but it must make a credible case for the business you are buying, its market and your plans to reach that market - whether you're buying a widget manufacturer or a bottle shop. It should include what you propose to do with the business you are buying, whether you intend to simply run it as it is or improve it.

Valuation

You will need to provide evidence of the value of the business you are buying. Where possible, this should be undertaken by a professional, such as an accountant or valuation expert who is paid to give a professional business appraisal.

In the case of a property-based business, such as a restaurant or hotel then a surveyor’s report will help value the bricks and mortar. If the business is not property based (for example a PR company or a recruitment consultancy) then you will probably be using a multiple of that business's earnings. For example, many businesses are currently valued between three and eight times their profit.

Selling agent's details

You will be required to provide contact details for the agent representing the business or the vendor's details if you are buying directly from the seller.

About yourself

Curriculum vitae

A CV with details of your previous work experience will be needed. Keep this short and to the point and outline any relevant experience that will help persuade the bank that they are reducing risk by lending to you.

Asset and liability statement

This will detail what you own (such the equity in your home or shares) and what you owe - including credit card debts and other outstanding loans.

Bank statements

Normally, you will be required to make bank statements available for the last six to 12 months. Anti laundering and fraud legislation now require proof of your ID and residency, such as photocopies of your passport.

If you do intend to go down this route (borrowing money from a bank) it's important to spend time researching the various loan products available to you. For example, longer term loans but with lower interest rate payments may be preferable to a shorter-term loan with a higher interest rate.

In other words, don't just look at the interest rate - look at the term. For example:

  • Loan A for R1 000 000 at base rate + 2%, over 10 years, will work out at R11 100 per month
  • Loan B of R1 000 000 at base rate + 3%, over 20 years, will work out at R7 100 per month

Even though you are paying pack the loan on a higher interest rate with example (B), because you are paying it back over a longer period (20 years, as opposed to 10 years) you are paying R4 000 less per month.

In cash flow terms that difference could be very important to you in the early stages of your new business - crucial, in fact. Therefore, don't automatically look at the interest rate - consider the term too.

If you decide to finance your purchase without the use of a bank you may also wish to consider the following options:

Business finance specialists

These are brokers that help business buyers and owners get the best deal. Generally, they’ll have access to hundreds of different providers and be brand agnostic; meaning they’ll offer you the finance that’s right for you, regardless of their commission structure.

It’s worth noting that not all brokers are alike. Some will charge commission to the prospective business owner, while other charge the lender.

Either way, having access to a variety of options will help you make a measured and informed decision.

Government Grants

The Department of Trade and Industry (DTI) and associated organisations such as the Small Enterprise Development Agency (SEDA) are who most government loans for businesses come through.

These loans will often come with terms that are a lot more flexible than those from other financial organisations.

There are several loan programmes that will be worth considering such as Isivande Women’s Fund, Khula, and the National Youth Development Agency (NYDA) .

It will be important to do as much research as possible in order to find government business loans with criteria that matches your business.

Private investors

They are often referred to as 'angels' or 'high net-worth individuals' and these private investors - looking to back new ventures with potential - now make up a sizeable group. The growth of these backers - the same type of people that may invest in art or property - is partly attributable to some poor stock market returns of late.

You can connect with potential angel investors through platforms like The Angel Investment Network and Jozi Angels

They may not be investing with the might of venture capital firms, but their ethos is the same - a good return on their investment in a short period of time.

So, if you have plans to buy a business or two, consolidate them and then float on the stock market these are the type of people you might want to approach.

Venture capital funds

There are over 250 venture capital funds in South Africa who seek to invest in exciting business ideas with high growth prospects, products and services with a competitive edge and highly skilled management teams.

However, if you are likely to be a business owner interested in running a lifestyle business (a business whose main purpose is to provide a good standard of living and job satisfaction for you as an owner) then you are unlikely to provide the high financial return that venture capital investors are looking for.

Some venture funds look to invest R10m with the expectation of making R50m (or more) within three years. This is not a loan and you will have to give up a big stake in your business.

The investor will generally expect to be actively involved in your company and its progress. However, you may have big plans to consolidate a business sector, like nurseries for children or fast food outlets and venture capital might be the way to go.

Crowd funding

This is one of the newest ways to raise finance. Essentially, it's the process of individuals or groups pooling money to fund other groups, individuals or businesses. It's not regularly used to help people purchase pre-existing businesses, but there are those that have had success on site.

There are numerous nuances within crowdfunding, though in comparison to most other methods of raising finance, there's a lot of transparency as campaigns perform much better when social media is involved.

You may find it useful to speak to an accountant before jumping in to alternative forms of funding, but hopefully you're better prepared to make the right decision when it comes to raising finance.

Doing as much research as possible will help you make the right decision, or, if you're ready to look at businesses for sale, there are thousands that you can go through to make sure that you find the one that is right for you.


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