How to finance the purchase of an existing business in Australia

How to finance the purchase of an existing business in Australia

Buying an established business can provide immediate access to customers, employees, systems, revenue and cash flow.

Financing the acquisition, however, is not as simple as borrowing a percentage of the purchase price. Unlike a commercial property, a significant portion of a business's value may consist of goodwill rather than tangible assets.

That means lenders need to understand both the business being acquired and the purchaser taking control of it.

If you're considering buying a business, understanding how lenders assess these transactions can help you work out how much you may be able to borrow, what contribution you'll need and how to prepare your finance application.

What is business acquisition finance?

Business acquisition finance is funding used to purchase an existing business or an ownership interest in one. It may be used for acquiring an entire business, buying out an existing shareholder, acquiring a competitor, purchasing a complementary operation, management buyouts or succession transactions.

The appropriate finance structure depends heavily on what is being purchased.

For example, acquiring a business with substantial equipment and property assets may involve different lending arrangements from purchasing a professional services firm whose value lies primarily in its client relationships and goodwill.

Depending on the transaction, finance may involve a business acquisition loan, property-secured lending, equipment finance, vendor finance or a combination of funding sources.

What will a lender assess?

A lender will generally consider two distinct risks: the target business and the purchaser. It will ask whether the target is profitable, sustainable and capable of servicing the acquisition debt, and whether the buyer has the experience, financial position and equity to successfully operate the business.

In particular, lenders will want to understand:

• The target business's historical financial performance and sustainable earnings
• Its ability to generate enough cash flow to service the proposed debt
• The amount of goodwill included in the purchase price
• The purchaser's management and industry experience
• The buyer's available equity and security
• The proposed ownership and loan structure
• The working capital required after settlement

The importance of each factor will vary depending on the business, purchase price and lender.

Understanding EBITDA

EBITDA (earnings before interest, tax, depreciation and amortisation) is commonly used when analysing established businesses. It can provide an indication of underlying operating profitability before financing and certain non-cash costs.

However, lenders do not necessarily accept the reported EBITDA without adjustment. They may analyse owner salaries, related-party expenses, one-off costs, non-recurring income, rent, management costs, normalised wages and future capital expenditure.

The objective is to determine what level of sustainable earnings is likely to remain after the acquisition.

Importantly, EBITDA is not the same as cash flow. A business may report strong EBITDA but still need substantial funds for stock, equipment replacement, tax obligations or other working capital requirements.

Lenders therefore consider EBITDA alongside other financial information when determining whether the business can afford the proposed loan repayments.

Why normalised earnings matter

A business may appear highly profitable because the current owner performs several roles while drawing a below-market salary. If the purchaser needs to employ a manager after settlement, the additional wage cost can reduce sustainable earnings.

Conversely, genuine one-off expenses may potentially be adjusted. A lender therefore looks beyond the headline profit number.

For example, imagine you're purchasing a business that reports $400,000 in annual EBITDA. The current owner manages day-to-day operations but receives a salary well below the market rate.

If you intend to employ a manager at an additional annual cost of $100,000, the business's sustainable earnings could be materially lower than the reported figure, assuming other factors remain unchanged.

That difference can affect how much a lender is prepared to advance.

This is why it's important to understand not just what the business has earned under its current owner, but what it is likely to earn under your ownership.

How much deposit is required?

There is no universal percentage. The required contribution can depend on business type, strength and consistency of earnings, purchaser experience, tangible assets, property security, goodwill, lender appetite and transaction size.

An acquisition backed by commercial or residential property may be financed differently from a transaction consisting almost entirely of goodwill.

For example, a purchaser with equity in an existing property may have more financing options than someone relying entirely on the assets and earnings of the business being acquired.

However, contributing more cash isn't always the best approach if it leaves the business without enough working capital after settlement. The deposit and finance structure need to be considered alongside the funds required to operate the business.

Can banks finance goodwill?

Yes, some lenders will consider financing goodwill as part of a business acquisition.

Goodwill represents the value of a business beyond its identifiable tangible assets. It can include customer relationships, brand value, systems and established earnings.

Because goodwill cannot generally be sold as readily as property, lenders can treat it differently from hard security. The stronger and more predictable the underlying business cash flow, the more options may be available.

For example, an established accounting practice may have relatively few tangible assets but derive substantial value from its recurring client relationships. A lender considering the acquisition would need to assess the sustainability of that revenue, including the likelihood of clients remaining after the ownership change.

The amount a lender is prepared to finance will depend on its appetite for the industry, the business's earnings, the purchaser's experience and the overall transaction.

What financial information will a lender request?

For an established acquisition, information can include historical financial statements, business tax returns, current management accounts, BAS statements, purchase contract, information memorandum, proposed ownership structure, purchaser assets and liabilities, purchaser experience, business plan and cash-flow forecasts.

The lender may also request information about existing loans, major customer contracts, property leases, employee arrangements and any assets included in the sale.

The lender may also want to understand why the vendor is selling and whether key customers or staff are likely to remain after settlement.

Having this information available early can help identify issues that might affect the lending assessment or delay approval.

Don't overlook working capital

A common acquisition mistake is concentrating entirely on the purchase price. The purchaser may also need funds for wages, stock, rent, supplier payments, insurance, marketing, professional fees and transition expenses.

If all available cash is contributed to the acquisition, the new owner can start with insufficient working capital. The funding strategy should therefore consider the business's post-settlement liquidity.

For example, you may need to pay staff and suppliers before receiving income from customers. There may also be unexpected expenses during the transition, particularly if the business needs new systems, equipment or additional staff.

Before finalising the purchase, it's worth preparing a cash-flow forecast that covers the first few months of ownership, including expected income, expenses, loan repayments and any one-off acquisition costs.

This can help you determine whether you need a separate working-capital facility in addition to the acquisition loan.

Vendor finance

In some transactions, the seller may agree to leave part of the purchase price outstanding. This is commonly known as vendor finance.

It can reduce the amount of external finance required at settlement, but lenders will want to understand the terms, repayment profile and priority of the vendor debt.

Vendor finance should therefore be incorporated into the funding strategy rather than negotiated separately without considering the senior lender.

For example, a vendor might agree to receive part of the purchase price over an agreed period after settlement rather than receiving the full amount upfront.

However, those future repayments still represent a financial commitment. The lender will need to consider how they affect the business's ability to service its other debts.

Vendor finance is not automatically treated as the purchaser's equity contribution, so its treatment should be confirmed with the proposed lender.

Why industry experience matters

Purchasing a profitable business does not guarantee the same performance after ownership changes. A lender may therefore place considerable weight on the purchaser's background.

Someone buying a business in an industry they have operated in for many years can present a different credit proposition from a first-time operator entering an unfamiliar sector.

If you're moving into a new industry, lenders may want to understand how you plan to manage the business and whether experienced staff or management will remain after settlement.

A clear transition plan can be particularly useful where the departing owner has been heavily involved in customer relationships, operations or business development.

Business valuation versus property valuation

Business valuations and commercial property valuations assess different things. A business valuation may consider earnings, maintainable profit, assets, market evidence and goodwill.

The purchase price negotiated between a buyer and seller does not automatically determine what a lender considers the business to be worth.

For example, you may agree to pay a premium for a business because of its growth potential or strategic value to your existing operations. However, a lender may take a more conservative view based on its assessment of maintainable earnings, available security and the risks involved.

This can affect the amount of finance available and the equity you'll need to contribute.

What should you check before buying a business?

Finance is only one part of a successful acquisition. Before committing to the purchase, it's important to carry out appropriate financial, legal and commercial due diligence.

Depending on the business, this may involve reviewing:

• Historical financial performance and current trading results
• Outstanding debts, tax obligations and other liabilities
• Major customer and supplier contracts
• Employee entitlements and staffing arrangements
• Commercial leases and any required landlord consent
• Licences, regulatory requirements and other approvals
• The condition and ownership of assets included in the sale
• The business's dependence on the existing owner

Your accountant and solicitor can help assess these matters, while a commercial finance broker can identify issues likely to affect the lending application.

Structure the finance before signing

Ideally, finance planning should begin before the purchase contract becomes unconditional. This provides time to assess borrowing capacity, purchaser contribution, security, lender appetite, due diligence requirements, working capital and loan structure.

It also allows you to identify any finance conditions, approval timeframes or additional security requirements that need to be considered before committing to the transaction.

For more complex acquisitions, the finance structure may need to account for multiple entities, different asset types or funding from several sources. Addressing these issues early can help reduce the risk of delays as settlement approaches.

Plan your business acquisition finance before you commit

Buying an existing business can be an opportunity to acquire an established customer base, proven systems and an existing income stream. However, securing finance involves demonstrating that the business can continue generating sufficient earnings and cash flow under your ownership.

3LANE Finance works with business owners across acquisition, expansion and commercial property transactions. We review the target business, purchaser, financial performance, proposed structure and available security before comparing lenders.

Where a transaction is complex, we prepare the lending proposition so the lender can clearly understand the acquisition, historical performance and proposed repayment strategy.

If you're planning to acquire a business, speak with 3LANE Finance early in the process so you can understand your borrowing options, likely equity contribution and finance requirements before committing to the purchase.

Talk to a 3LANE business finance broker

Important: This article provides general information only and does not constitute financial, legal, tax or credit advice. Lending criteria and policies vary between lenders and can change. Obtain advice appropriate to your circumstances before acting.