What to spend in buying a business? Determine your budget.
This will be determined by your ability to manage the businesses
monthly cash flow, your cash reserves, equity you may borrow against, the bank
and/or vendor finance. Exercise care in not taking on too much debt, and ensure
you allow for working capital and some cash reserves.
As with anything, we are usually attracted to the best and most impressive
looking car, boat, house or business, seeing the lifestyle it can provide. This
usually leads to looking at high profit businesses, and with that usually comes
the higher price tags. So maybe you are able to extend yourself - you're got
the vision, enthusiasm, and a lot of good ideas to implement. Unfortunately
there are also a lot of variables in the business world, a number of which can
and do lead too failure.
The best position is to reduce your risk. Don't spend the lot, struggle to keep
things afloat, and then risk loosing it all. Exercise common sense, spending
less will reduce your risk. Additional monies can be used at a later stage to
expand or grow the business, once you have a thorough understanding of what the
business takes.
Obviously, every business purchase is situation and business specific,
therefore difficult in determining how much should be spent.
Here are some
general guidelines:
1. You need to consider all the factors; don't over look the monthly cash
flows, sufficient working capital, possible vendor finance, and the
professional fees.
2. Always keep some in reserve for that rainy day - look to what could be your
biggest and most likely contingencies, and manage this risk. It is likely to
require putting away some cash reserves as a safe guard in those early more
vulnerable years.
3. Initially borrow more than you need, this will be the easiest time to get
funds - if in 12 months time your new business is struggling and is in need of
a cash injection. The bank is highly unlikely to want to lend you more. This
could be by way of additional funds borrowed but not drawn on, or establishing
a good overdraft facility at the time of purchase. Keep this in place until
you're comfortable that you can financially manage your way through the ups and
downs.
4. You're likely to be borrowing against assets. When doing this look to
maximise your borrowing against the new businesses assets - this may require
using the services of a Finance company. It's always easier and cheaper to
borrow against the family home - but it may not help you sleep easily.
5. You're also likely to need some bank financing. Banks are risk averse; they
like houses and are nervous on businesses. Business borrowings are therefore
likely to be secured against family homes (where possible), or other key
assets. They will want your proposed business able to generate sufficient cash
flow after expenses before they give you a loan. After all they want to see you
can meet your financial obligations. Banks are an important part of the
equation, they;
(a) Will usually look at the interest cover, one such calculation is;
(net profit + interest costs) / interest costs = interest cover.
Ie. ($30,000 + $16,000) / $16,000 = 2.8
Anything less than 2 suggests the business has too much debt.
(b) Want security, and will usually lend only 45 - 65% on the tangible business
assets valuation, depending on the perceived risk in having to cash-up the
particular asset. Want to see 3 years of trading trends, and are generally more
comfortable lending on proven franchise systems as this factor tends to improve
a businesses success.
Strengthen your bargaining position before you find your business to buy...
Find out how much business finance you can get.
Richard O'Brien is the Managing Director of nzbizbuysell - an online
advertising site dedicated to the buying and selling of New Zealand businesses.
For more information visit nzbizbuysell
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