Finance to buy a business: how acquisitions are funded

Buying an existing business can be a faster route to growth than building one from scratch. You get customers, staff and a trading record on day one. You also need to pay for it, and the price is usually far more than most buyers have in the bank.

The good news is that a profitable business can help pay for itself. Lenders will often lend against the target's assets and cash flow, and sellers often accept part of the price later. This guide explains each piece of the funding, how they fit together and what lenders will want to see.

The funding stack

Think of the price as a stack of money from different sources. Each layer carries a different level of risk and gets repaid in a different order.

1. Your own money, called equity. It's the first money lost if things go wrong, so lenders want to see you have some at stake.
2. Vendor finance, where the seller agrees to receive part of the price later.
3. Lending, which may be a single acquisition loan or a mix of loans and facilities secured on the target's assets.

The mix depends on the deal. A business with property, equipment and a healthy debtor book can support more borrowing than one whose value is mostly in its people and reputation.

Your own money

Almost every lender expects the buyer to put in some cash. How much varies widely with the deal, the lender and your track record, but a meaningful share of the price is normal. It shows commitment, gives the lender a cushion and means you share the risk.

Your contribution can come from savings, the sale of another business, investors or a partner. If you borrow it personally, tell the lender: it changes the risk, and a lender may not count it as equity. Borrowing against your home to fund a purchase puts it at risk if the business struggles, so take independent advice first.

Vendor finance: paying the seller later

Vendor finance means the seller agrees to take part of the price after completion rather than on the day. It's also called deferred consideration. It's very common in smaller deals, and it's often what makes the numbers work.

It usually takes one of these forms:

• Fixed deferred payments. A set amount paid in instalments, often over one to five years, sometimes with interest.
• A loan note. A formal written promise from the buyer to repay the seller, with set dates and interest.
• An earn-out. Part of the price depends on how the business performs after the sale, for example a share of profits above an agreed level.

Vendor finance helps everyone. You need less cash and less borrowing on day one. Lenders like it because a seller who's still owed money has a reason to hand over the business smoothly. If the seller won't accept any deferral, a lender may wonder why.

Expect a lender to require the vendor finance to rank behind its own lending. That means the seller is paid only if the business can keep up with the lender's repayments, which is set out in a formal agreement between the lender and the seller. Sellers who want more certainty may ask for security of their own, ranking behind the lender.

Acquisition loans

An acquisition loan is a term loan to fund the purchase, repaid from the target's profits over a few years. Lenders usually size it from the target's profit before interest, tax, depreciation and amortisation (EBITDA), a rough measure of the cash the business generates. They'll want comfortable cover over the repayments, including any payments to the seller, rather than lending the maximum the numbers will bear.

The loan is usually secured. Typical security includes:

• A debenture over the target's assets, which gives the lender fixed and floating charges. Our guide to secured vs unsecured business loans explains how these work.
• A charge over the shares you're buying.
• Personal guarantees from the buyer, especially in smaller deals. Read personal guarantees explained before you sign one.

Many buyers set up a new holding company to buy the target's shares. The lender lends to that company, and the target pays money up to it to cover the repayments. Your solicitor and accountant will advise whether this structure suits you.

Asset-backed lending and invoice finance

Some of the money can come from the target's own assets, often more cheaply than an unsecured loan:

• Property. If the business owns its premises, a commercial mortgage can release a large share of the value over a long term.
• Equipment and vehicles. An asset finance lender may lend against machinery or vehicles the business already owns, called asset refinance.
• Invoice finance. If the target sells to other businesses on credit, an invoice finance provider can advance most of the value of its unpaid invoices. That can release money at completion and keep doing so as the business trades. See invoice finance vs a business loan for how it works.

Some lenders combine these into one asset-based lending facility, with a term loan alongside. Mixing sources can raise more than a single loan, but each lender will want to know about the others, and agreeing who ranks first takes legal work.

A worked example. A buyer agrees to pay £500,000 for an established distribution company that makes around £150,000 a year before interest, tax, depreciation and amortisation. The buyer puts in £100,000 of their own money. The seller agrees to take £150,000 over three years, so £50,000 a year, ranking behind the lender. The remaining £250,000 comes from lending: a £175,000 acquisition loan over five years, secured on the business with a personal guarantee, plus £75,000 released at completion by a new invoice finance facility on the company's unpaid customer invoices. The loan repayments of about £35,000 a year plus interest, and the £50,000 a year to the seller, leave room within the £150,000 profit for tax, investment and surprises. The buyer also budgets separately for legal, accounting and due diligence costs. This is an illustration, not a quote: your own deal will depend on the business and the lender.

Buying shares or buying assets

There are two broad ways to buy a business, and the choice affects the finance, the tax and what you take on.

Because you inherit the company's history in a share purchase, the protection in the sale agreement, such as warranties and indemnities from the seller, matters a great deal. The right structure depends on the business and your circumstances, so decide it with an accountant and a solicitor who handle business sales.

What lenders want to see

Acquisition lending is judged on three things: the target, the buyer and the deal.

The target. Usually three years of filed accounts, recent management accounts, bank statements, a breakdown of customers and suppliers, and details of any existing debt. Lenders look for steady profits and no heavy reliance on one customer or on the seller personally.

The buyer. Your experience matters a lot. A buyer who has run a similar business, or is already part of its management, is a far easier case than someone new to the sector. Expect to provide a CV, a personal financial statement and evidence of your own contribution.

The deal. The agreed price and how it's funded, the heads of terms (a summary of the agreed deal before contracts), a business plan with forecasts, and the findings of due diligence: the detailed checks of the target's finances, tax, legal position and contracts. Lenders often rely on the accountant's due diligence report.

Common mistakes to avoid

• Agreeing a price before testing the funding. Know roughly what lenders will support before you commit to a number.
• Forgetting the seller's payments. Lenders count vendor finance repayments. So should you, when working out what the business can afford.
• Relying on a business built around the seller. If customers buy because of the owner, plan a handover period and expect lenders to ask about it.
• Skimping on due diligence. It costs money, but finding a tax or legal problem after completion costs far more.
• Leaving no working capital. Paying for the business is not the end. Make sure it still has cash to trade the day after.

Questions people ask

Can I get a loan to buy a business?

Yes. Many UK lenders offer acquisition loans, usually secured on the business being bought and with a personal guarantee from the buyer. Lenders look mainly at the target's profits and the buyer's experience, and expect the buyer to put in some of their own money.

How much deposit do I need to buy a business?

There's no fixed figure. It depends on the target's profits and assets, how much the seller defers and the lender. Expect to fund a meaningful share of the price yourself, with vendor finance and lending covering the rest.

What is vendor finance?

Vendor finance, or deferred consideration, is where the seller accepts part of the price after completion rather than on the day. It's usually paid in instalments or linked to future profits through an earn-out. Lenders like it because the seller stays invested in a smooth handover.

Can I use the business's own assets to fund the purchase?

Often, yes. Lenders can secure finance on the target's property, equipment or unpaid invoices, and that money can help pay the price. It needs careful legal structuring, so your solicitor will set out how the security is given.

Should I buy the shares or the assets?

It depends on the business, the tax position for you and the seller, and the risks you'd inherit. Buying shares takes on the whole company, past liabilities included, while buying assets lets you choose what you take. Get advice from an accountant and a solicitor before you agree.