Lender's Preference is Loaning on an Existing Business
Union Bank & Trust's Cassie Kohl on Cash Flow
For some entrepreneurs, buying an existing business represents less of a risk than starting a business from scratch. According to Michael Gerber, author of The E-Myth Revisited, 40% of new businesses fail in the first year and 80% will fail within five years. Beyond the dangers of dissolution, many startup businesses have trouble securing conventional bank financing as they present a risk to lenders. The result is nearly three-quarters of startup businesses are funded though the owner’s personal resources.
There are several advantages to purchasing an existing business as opposed to starting one from scratch for both the entrepreneur as well as the bank.
- Historical financials: a lending institution will be more likely to fund a transaction when historical revenues show the cash flow can support the purchase price and debt payments. This is far less risky than issuing a loan with projections that may or may not be realized.
- Seller-assisted financing: the lower the loan amount in relation to the purchase price; the more comfortable the bank will be. One way to accomplish this is by the seller financing a portion of the purchase price. This is especially helpful when the buyer does not have a lot of cash to put into the deal.
- Collateral: in an asset sale, you will be acquiring equipment, receivables, inventory, etc. that can be used to secure the loan. With a startup, you will most likely need equity in your personal property to compensate for the lack of collateral.
- Proven Concept: when buying an established business, you already know the process or concept works. Financing a purchase is often easier than securing funding for a startup for that very reason-the business has a track record.
- People: in an acquisition, one of the most valuable and important assets you’re buying is the people. Knowing an established management team is already in place provides additional comfort to the bank.
"There are several advantages to purchasing an existing business as opposed to starting one from scratch."
For lenders and entrepreneurs, a major goal is to mitigate risk and maximize returns. By purchasing a business with established cash flows, a customer base, an intact management team and collateral, entrepreneurs can convince lenders that financing is more than simply betting on an idea.