What are the financing options for buying a business?

So, you’re thinking of buying a business, but you don’t know where to start. Getting financing options for buying a business can make or break many ambitious entrepreneurs thinking about making the leap. But the good news is that there are plenty of options on the table that allow your dream of buying an existing business to become a reality.

And guess what, over the years we’ve been fortunate enough to help our fair share of business owners and entrepreneurs make that big, exciting purchase. Using the experience we’ve gathered over the years, we’ve compiled some of our pearls of wisdom below.

So, without further ado, let’s get into it.

DIY: Self-financing Options

It might seem obvious, but the first thing to consider before you cast your net out is whether you can finance the purchase yourself, either in full or in part depending on your financial situation.

Personal Savings are the most straightforward way of funding a purchase without needing to pass control or ownership to external financers. It gives you full control over your financing and means you won’t need to answer to investors.

However, it is also probably the most difficult.

In reality, most people will struggle to save the substantial amounts needed to buy a business.

Friends and Family

Again, this might not be an option for everyone, but sometimes charity starts at home. Asking friends or family for a loan allows you to avoid the red tape and high interest rates of regular financing options. However, that’s not to say it should be treated with any less diligence.

If you are getting a loan from friends or family, make sure to write out the terms and conditions of the loan or have a loan agreement drafted by a professional to make sure there is no room for misunderstanding.

Personal Loans

One of the most popular options for financing a major purchase like buying a business is personal loans from banks or online lenders.

Nowadays, numerous options for funding are widely available to individuals with a decent credit history, and the application process is often streamlined compared to other forms of financing.

As with any loan, it’s important that you fully understand the terms and conditions of repayment, so you’re not trapped into an unfavourable deal.

While personal loans provide a relatively quick and convenient funding source, they also come with certain risks. If you are taking out the loan in your name, you will be personally liable for any default. You won’t be able to take advantage of the limited liability status of a limited company.

Financing options for buying a business using ‘special-purpose vehicles’

You should carefully assess your ability to repay the loan comfortably, considering factors such as income, expenses, and other financial obligations. Defaulting on a personal loan can have serious consequences, including damage to credit scores and potential legal action from lenders.

Given the above you may consider setting up a special purpose vehicle (limited liability company for the purchase), to attempt to limit any personal liability. Setting up this ‘special-purpose vehicle essentially means that if you fail to pay back the loan, the limited company and its assets will take the hit, while your assets remain safe.

Note that by doing this the lender may assess the company’s ability to repay the loan, so if you set up a business that was making no money and had no assets, you probably won’t get the loan. In addition, when using a special-purpose vehicle financiers might still require you to guarantee that loan.

Equity Financing

Outside of traditional bank loans, equity financing offers entrepreneurs the opportunity to raise funds for the purchase of a business. When buying a business, equity funding essentially involves giving away a share of the business to an investor in return for an investment. There are many types of Equity Financing.

Angel Investors

Angel investors, typically affluent individuals, offer capital in exchange for ownership equity or convertible debt. This not only provides financial support but often comes with mentorship and opportunities to benefit from the investor’s existing network.

Venture Capital

Venture capital, on the other hand, involves investment from professional firms, often requiring entrepreneurs to undergo rigorous due diligence processes to ensure they’re a safe bet. This can also result in a hefty equity dilution which is the cost of the significant capital injections and access to industry expertise.

Private Equity

Private equity firms focus on established companies, acquiring controlling stakes and implementing value-creation strategies, though this may entail significant operational changes and conflicts with existing management.

Venture Capital vs Private Equity

What’s the difference between private equity and venture capital? Venture capital tends to focus on early-stage startups with high growth potential, while private equity targets more mature companies with established revenue streams.

Crowdfunding

In addition to the more tried and tested methods above, another way of raising funds that has gained popularity, particularly in the last 10 years, is crowdfunding.

Crowdfunding offers a more democratic approach to financing, by using online platforms to raise funds in exchange for rewards, equity, or debt. Although it offers more accessibility than traditional methods, success does depend heavily on effective marketing and putting yourself out there to attract investors. Admittedly it’s not for everyone, but it has its benefits.

Considerations with Equity Financing

Overall, equity financing provides access to substantial capital and strategic support but involves risks such as equity dilution, loss of autonomy, and high investor expectations. As a result, it requires careful consideration to make sure the method chosen aligns with your long-term goals.

Seller Financing

Seller financing, AKA owner financing or vendor financing, is a transaction arrangement in which the seller of a property or business provides financing to the buyer, letting them purchase the asset without needing traditional bank financing. In seller financing agreements, the buyer makes payments directly to the seller over an agreed period, (usually with interest, of course).

This method lets buyers acquire assets without relying solely on external lenders, while sellers can benefit from earning interest on the financed amount.

Seller financing offers benefits for both buyers and sellers. It provides an alternative financing option, flexibility in terms, and potential financial gains. However, it also involves a lot of potential problems such as credit risk, interest rate risk, and legal compliance considerations, which would require careful assessment and backup plans to ensure a successful transaction for all parties.

A Combined Approach

Combining a mix of the strategies above is often the way forward for a lot of entrepreneurs in the UK. Some blend equity and debt by utilising venture capital alongside seller financing or crowdfunding combined with angel investment. When this is the case, it’s incredibly important that each entity is aligned objectively. It also relies heavily on a thorough due diligence process to wheedle out any problems and make sure everything is legally compliant.

Wrapping Up

So, there you have it, a brief overview of the different financing options for buying a business. For any of you entrepreneurs out there, it’s important to remember the diverse financing options available for purchasing a business in the UK. From self-financing to equity and seller financing, each avenue offers its own set of advantages and considerations.

However, navigating these options requires thorough research and seeking professional advice. With the dynamic nature of the UK market, exploring financing options carefully is key to achieving your business dreams. If you’re looking at financing options for buying a business and need personalised guidance and support tailored to your specific needs, don’t hesitate to reach out to our legal team at Accounts and Legal.