Business Acquisitions: What you need to know
Business Acquisitions are commercial loans to assist client’s with buying a business. These loans are more complex then a home loan and involve several concepts:
Leasehold vs Freehold: When buying a business, you are usually buying the business as a Leasehold or a Freehold. Leaseholds are when you acquire a business as well as take over the lease of the business premises. Freehold is when you acquire both the business and the commercial property. Depending on the scenario, each has their own set of requirements.
Leasehold requirements = Bank Guarantees: When taking over a business lease, it is expected that you require a bank guarantee/bond to securitize the new lease agreement. The standard expectation for this bond/guarantee is that the amount required is equivalent to 3-6 months of the rental expense. A bank guarantee is sourced from a bank or lender which allows the noted parties to cash-out the guarantee for it’s value. To source a bank guarantee, you need to offer property security or cash equivalent to the value of the guarantee.
Leasehold requirements - Right of Entry: A non-negotiable bank requirement for leaseholds is a mortgage over lease and a right of entry clause signed by the landlord. These items allow the bank to access the business premises with the landlord’s permission to claim business assets in the event of loan default. This item is normally a main item to discuss with the vendor upfront as this normally requires negotiation with the landlord on what conditions they would be open to on the right of entry clause.
Funding Requirements: As outlined above, there are generally numerous funding requirements in acquiring a business. A business does not instantly become profitable from day 1 with no cashflow to purchase stock and pay staff. A general requirement as a result is to attain a Line of Credit Facility with the business acquisition loan to assist with the first 6 months of business expenses such as stock, labour and operational expenditure.
Client Contribution: Lenders offer different loan amounts (LVRs) depending on the industry of the business. As a general rule of thumb, bank’s offer 50% of the purchase price for a business acquisition loan. Exceptions include Professional Services, if the business is under a bank’s Accredited Franchise List and available security.
Management Experience: The experience of an applicant in the industry of the business being purchased plays a vital role in lender appetite. The loan is based on a group basis and without sufficient management experience, relying on the income of the business being purchased is difficult. Lenders generally want 2 years of industry experience to reliably use cash flow forecasting in loan assessment.
Loan Assessment: Business Acquisition loans are assessed on a group basis including the new business being purchased. Document requirements are financial statements and tax returns of the client’s along with the business being purchased, supported by a Business Plan and Cashflow Forecast, with Accounting Assumptions clearly outlined. Non-recurring items are added back so if a client ceases their current role to take over the new business, the assessment would not include the client’s current income.
Security: Unless the loan is fully secured by property and is below $1M of business lending, it is a non-negotiable requirement for a lender to take an unlimited guarantee over the businesses known as a First Ranking General Security Agreement. This charge restricts further bank business lending to the businesses until the loan is cleared which is why all funding requirements are done upfront. When looking at further business lending with this charge, this would need to be refinanced as part of the new loan for a bank. Non-bank lenders can extend further funding with this charge but generally charge a higher rate in return.
Assigning Business Value: A common concern with client’s are if the purchase price of a business is a fair reflection of the value of the business. From a bank’s perspective, business value is normally determined by a 3 - 3.5x multiple of EBITDA (Net Profit + Interest + Depreciation +/- Non Recurring Items). If the purchase price exceeds this, then an explanation on how the purchase price has been determined such as IPs, trademarks and non-tangible assets is required.
At Loan Central Hub, we are experts in business acquisition lending. Whether you are interested in starting your own business, entering into a franchise or looking to expand your business portfolio, Loan Central Hub can assist you with navigating through finance with confidence.
