Buying a business: the most important things to know

Finance Apr 26, 2021

6 min read

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Before agreeing to buy an established business there are number things you need to consider, particularly if you are borrowing funds to complete the purchase.

Purchasing an existing business

Much of the legwork you need to do before buying a business is conducting your due diligence. This means completing a valuation and working through the sales process with your Accountant and Lawyer. It’s also important to spend time in the business to understand its unique operations, who are the key customers and suppliers, who are the key staff members. Verify the sales volumes, understand what risks there are when the vendor exits the business, can these be mitigated with contract conditions?

Once you’ve decided you want to buy the business, and require funding to complete the purchase, here’s what you need to know.

Is industry experience important?

Yes. Whilst some people enter an industry and “disrupt” the status quo, it’s far more likely that the business will fail. Estimates are that 60% of businesses will fail within their first three years. To help improve your chances of success, experience in the industry or in the operation of a business is necessary, especially if you are borrowing money to purchase it. Banks want to understand what experience you have and what skills you are going to bring to the business to ensure it will continue to be successful.

Have you run a business before? What’s skill gaps exist? Who are your trusted advisors? Do you have an entourage for your business?

What contribution do I need? How much will the bank fund?

To qualify for bank lending you will need to contribute with either cash or equity in a property. Banks generally do not want to take on 100% of the risk in a business.  If things don’t work out it becomes too easy for the borrower to walk away – you need to have “skin in the game”.

If you are contributing cash you’ll probably need a 50% deposit, or if you are using equity in an existing property you may be able to finance the entire lend. However, every situation is different, making it important to talk to a broker to see what financing options might be achievable with your contribution level. 

Is the business’s historic performance important?

Very. You might think you’re getting a bargain swooping in and purchasing a struggling business which you plan to overhaul and turn into a goldmine. Unfortunately, the bank probably isn’t going to feel the same way. When buying you’re going to need to show 12 months of profitability and consistency across that year.

The good news is when it comes to profitability there are some things the bank will allow you to add back that the previous owner may have expensed. For example, if the previous owner put a lot of personal expenses through the business such as cars, phone bills and insurances you may be able to add these back in for a true reflection of the profitability (assuming you’re not planning on putting all of your personal expenses through too).

Future performance is also important too, is it a growing or declining industry?

What documents would I need to obtain & provide?

The bank will need to see a Profit & loss statement/Business activity statement, the Contract of sale, a Lease agreement (If applicable) and any applicable licenses. They’ll also want to see your Individual tax return and Company return (if applicable), proof of funds to complete and your resume. In some cases, they’ll want to see your business plan and cashflow forecast too.

Buying a business is a big commitment, ensuring you have a group of trusted advisors on hand to guide you is going to be the key to your long-term success.