Can you borrow money to buy a business?

A loan to buy a business is assessed on two things: the security the lender can rely on, and the ability of the business to make the repayments. The purchase price is normally broken into goodwill, plant and equipment, and stock. Equipment can be funded through asset finance secured against the equipment itself. Stock is often covered by an overdraft or working capital facility. Goodwill is the difficult part, because it has no resale value if the business fails. The main loan usually sits against goodwill, property or both. The full set of structures is covered on the loans to buy a business page.

For the business, lenders want two to three years of financial statements and tax returns, recent BAS, year to date management accounts, the sale contract, the premises lease and any franchise agreement. The assessor adjusts the vendor's profit for add-backs, such as one-off costs and owner-specific expenses, then deducts a market wage for the new working owner. The remaining maintainable earnings are tested against the proposed repayments. A common benchmark is earnings of at least 1.25 to 1.5 times the annual debt commitments.

For the buyer, lenders want a statement of personal assets and liabilities, identification, evidence of the deposit and its source, personal tax returns and a resume showing relevant experience. Two to five years in the same industry is a common expectation. A short business plan helps, covering the handover from the vendor, key staff, major customers and the first 12 months of cash flow. Where the borrower is a company or trust, the directors are asked for personal guarantees. Credit history is checked for the buyer and any guarantors.

The answer depends on the security. With no property, most lenders advance up to about 50% of the purchase price against goodwill and business assets. Specialist lenders go higher for professions with stable, recurring income, such as medical, dental, veterinary and accounting practices, and for pharmacies, childcare centres, rent rolls and accredited franchises. Unsecured cash flow loans are an option for smaller purchases, but most are capped at around $250,000 to $500,000, run for short terms and cost more. The balance of the price has to come from the buyer's own funds or from vendor finance. Typical contributions are set out in how much deposit you need to buy a business.

Property is the reason many purchases get funded at all. A lender relying on a mortgage over a home commonly advances up to 80% of its value, less any existing loan. Against commercial property the figure is commonly 65% to 70%. Because the loan is measured against the property, the available equity can cover most or all of the purchase price, including the goodwill a lender would not otherwise fund. Terms are longer, up to 30 years on residential security, which lowers the repayments the business has to carry.

The trade-off is risk. If the business fails, the debt remains and the property secures it. Any co-owner of the property must sign the mortgage, and a spouse who guarantees the debt is usually asked to take independent legal advice first. The lender still tests servicing, so strong equity does not replace the need for a business that can cover its repayments. How the structure works in practice is explained in using home equity to buy a business.

Applications are most often declined for four reasons. The reported profit does not service the debt, usually because the asking price relies on cash sales that are not in the tax returns. The buyer has no experience in the industry. The premises lease is too short, with no options, to support the loan term. Or the price is mostly goodwill in an industry lenders avoid, such as cafes, restaurants and new concepts, and the buyer has no property to offer. Each of these can sometimes be fixed by changing the price, the contract terms or the security before applying.