Funding the purchase and avoiding the risks
In the last few weeks we have discussed the purchase of businesses. Today solicitor Manjit Kaur-Heer will focus on funding the business, an issue of money that is usually the first hurdle for a would-be entrepreneur. We will also discuss how to manage the risk around borrowing money.
The type of funding available to buy a business differs depending on whether the funding is required by a well-established individual or on the other end of the spectrum a young person just starting out in business without any credit history or money behind them. For fledgling business owners it may be that the only option is to have your own money on the line. For established business people a bank may lend anything up to 80% of commercial mortgages. There are of course a whole lot of options in between. The funding available and risks of each appear below:-
- Your own money. The risk in using your savings is that you don’t have anything for a “rainy day” and if things go wrong you lose them! On the plus side if the business does well the return on your savings may far exceed the interest you would earn in the bank.
- Grants. These remain one of the best sources of funding available to new, developing and established small businesses. The majority of grants are paid by national, local and, until we Brexit, European government to support deprived areas, to stimulate technology advances through research and development and to make both the local and national economy more competitive in certain sectors. Grants can range from anything between £500 to £500,000. Usually the larger the Grant the more complex the eligibility conditions. Some of these grants also have to be “match-funded,” meaning that the business also needs to raise some funding itself internally or externally to be eligible for the grant in the first place. Advice from the likes of the Chamber of Commerce is usually available as to the type of grants that might be available.
- “The bank of mum and dad”. On the positive side such support is invaluable. On the negative and at the risk of mixing metaphors the warning about mixing business with pleasure can come home to roost! The risk is that if the business fails and the loan cannot be repaid either at all or as agreed then you may end up in court against your family. To minimise the risk to family relationships the expectations of family lenders should be properly managed at the outset before the loan is made and everything should be recorded in writing. There is a presumption of advancement that can apply to monies paid by parents to their children. If your parents have not stated in writing that it is a loan this presumption if it applies could meaning the money is a gift and thus the parents would be deprived from getting their money back. The risk to family relationships does not only arise from a straightforward inability to pay; it can also stem from failed marriage, Insolvency and death all of which can impacts repayment.
- A loan from the seller of the business. The likelihood is the seller will retain an interest in the business in return for making a loan. This may lead to unwelcome interference by the seller in the running of the business that you may feel is your business.
- A loan from a bank or other lender. In good times banks have been known to lend anything up to 70% of the
the total price of the business. With commercial loans they have been known to go up to 80%. The rest whether it is 20% or 30% will be the deposit usually paid from your own money. Generally a bank will want to see the last three years business accounts to see that the business you are about to buy is a profitable one. They will want to be sure that the trends are in the right direction, that is the business is growing. They will usually also want to see at least 6 months’ worth of personal accounts. Once you have a loan the risk arises from failure to make timely repayments which can result in the bank serving a default notice to call in the loan.
- An overdraft. This isn’t likely to be viable for a new business but should be for an established business. The risk attaches to the fact that usually the bank can call in the overdraft at any time without any or at least not much notice. Usually though a business in trouble is on notice as it will be being monitored by the bank, perhaps escalation to a bank manager, daily monitoring or imposition of special measures.
- Alternative lenders. They will tend to lend to those whose credit history is poor so who cannot get a loan from a main-stream lender. As they are taking on extra risk the loan is likely to be subject to a very high interest rate. High interest rates can put a business under pressure meaning the business gets in to difficulty paying back the very loan it required to start and survive.
- “Crowd-Funding”. This may not be a reliable form of funding. Also amounts will probably be low unless your new business has caught the imaginations of the public!
- Assuming responsibility for an existing source of funding. This is a topic that requires its’ very own article as all sorts of things have to be addressed when taking over existing businesses and existing loans.
In summary the matters to consider when thinking about how to fund the purchase of a business are how much and will it be a mix of own money and a loan from a third party. With any form of loan always ask the question can the business afford to repay it and if it cannot what action will you take in the event of default. If the money is from parents is it a gift or a loan? Whichever it is what are the tax implications and also what happens if it is a loan but you cannot for whatever reason repay it. Most loans are repayable over time and you need to know whether the loan is a manageable short-term thing say 2 to 3 years or a 25 year commitment. If it is the latter what happens when you want to retire. You should also think about how much interest will be payable and will the loan be secured for instance over the family home? If yes does your co-owning spouse agree to this? If the loan is to a limited company are guarantors required. Are the guarantors good for the money? What is the extent of their liability? Is it limited? If there is more than one guarantor is their liability joint and several?
Call 02476 387821 and ask for Ajmer Kang on anticipating risk. If a dispute has already arisen then ask for Manjit Kaur-Heer or Lorraine Walker. You may also contact us by email on firstname.lastname@example.org; email@example.com or firstname.lastname@example.org