Purchasing a business can mean that you have to raise a large amount of cash. When doing so it is important to remember that you are going to need to raise finance to cover significantly more than just the purchase price. To make a success of the deal, the funding you have available will additionally need to cover the following. It’s also true to say that you will always need more cash than you thought you did, for example as below.

Since neither you nor your advisers will have a 100% reliable crystal ball, you will always want to ensure that you have a significant contingency reserve built into your cash to cover the inevitable ups and downs. This point is especially true if you’re buying a business that is in difficulty as it is likely to have stretched its creditors. Once you have bought the business you will not be able to rely on obtaining the same lengths of credit period as the business currently has.

Creditors will have been giving these periods unwillingly and, on seeing that a new owner has purchased the business, will often make the assumption that there is now more cash available. You may therefore find that doing the deal precipitates a rush for payment by existing creditors, so planning your working capital must take into account provision for payments to bring overdue creditors up to date, or a plan for how these are otherwise to be dealt with. Finally, do not forget to build into your valuation of the business, and the financing requirement shown by your cashflows, the level of interest and capital repayment in respect of the borrowing you undertake.

Where Do You Get The Money?

Funding a business purchase is a large subject, but in essence there are four main sources of money to consider at the outset.

Equity

Equity will come from a mixture of:

• your own equity (which in many cases essentially means borrowing against equity in your house);
• friends and family;
• your business;
• a venture capitalist (VC) who is backing the purchasing team;
• a business angel;
• joint or co-venture partners;
• the seller, if you can persuade them to take paper (shares in your company) as payment in whole or in part, rather than cash.

Grants And Soft Loans

These are of particular relevance in development areas.

Debt

This is by way of borrowing against the assets being purchased.

Most forms of borrowing money to finance a business (including mortgages, leasing and hire purchase, factoring and invoice discounting, and most overdraft arrangements) require the business to provide some form of security by way of charges over business or personal assets. The level of borrowing obtainable is therefore determined by the level of security you or the business have to offer.

The only usual sources of significant unsecured lending to your business will come from credit given to you by suppliers, and any unsecured loans you or friends or family decide to put into the business.

The Seller

This is by way of vendor finance (a form of debt) such as deferred consideration or an earn-out, or by paying the seller with shares in your company rather than cash.

In addition, once in control of the business you may look to run its finances in such a way as to maximise the cash retained in the business, a process known as bootstrapping. This usually involves:

• reducing or eliminating non-essential expenditure (what you don’t spend you get to keep);
• agreeing terms with suppliers that allow you longer to pay;
• keeping the level of stock held (and hence cash tied up) to a minimum;
• ensuring that customers pay you as quickly as possible so that you do not have excess money tied up in debtors.

 

This then allows you to build up the business’s financial reserves by retaining profit within the company and growing the shareholder’s funds.

The degree to which you believe you’ll be able to reduce the business’s requirement for working capital by use of bootstrapping techniques obviously reduces the overall amount of cash that you need to seek to raise.

Over-reliance on bootstrapping can, however, be dangerous, as for example, an MBI team bought out a £20m turnover manufacturing business. Critical to their assumptions was an expectation that they would be able to reduce both their costs and working capital requirements significantly by better purchasing. In practice they found that the old owner had already beaten suppliers’ prices down to rock bottom and there was little further saving therefore available to be made. The MBI ran out of cash and failed within a year.

Each of these sources is discussed below, but for more detail you should refer to the relevant chapters in Section B.