How small business purchases are really funded

The asking price of a business is one number. The way it gets paid is usually several. Understanding the parts is what turns "I cannot afford that" into "here is how this could work", and it also shows you when a deal should not be done at all.

The stack

Think of a purchase as layers. Each has a different cost and a different claim on the business.

Most small deals use two or three of these. Very few use only the first.

Your own cash

Every other party will ask how much of your own money is going in. A seller wants to know you are committed. A lender will insist on it. The amount varies by deal, but a buyer with nothing at risk finds few people willing to stand beside them.

Keep some back. A business that has just changed hands almost always needs working capital in the first months, and the buyer who spent everything on the price has no answer when it does.

Seller finance

The seller agrees to receive part of the price after completion, usually in instalments over one to five years, with interest. It is sometimes called deferred consideration or a vendor loan.

This is the most useful tool in small acquisitions. It lowers the cash you need on day one. It also tells you something: a seller who will wait for part of their money believes the business will keep earning under a new owner. A seller who refuses any deferral at all may be telling you the opposite.

Sellers will usually want protection in return, such as security over the shares or a personal guarantee. Take advice before you give either.

Earn-outs

An earn-out is a further payment that depends on results after the sale. If the business reaches an agreed level of revenue or profit, the seller receives more.

It is a way to bridge a gap. The seller believes the business is worth more than you do. An earn-out says: if you are right, you will be paid for it.

Earn-outs cause more arguments than any other term, because after completion you control the business and the seller is paid on the outcome. Keep the measure simple, write down exactly how it is calculated, and keep the period short.

Debt

Banks and specialist lenders lend against established businesses with steady profit. They look at how comfortably that profit covers the repayments, what security is available and who the buyer is.

In the United States, many small acquisitions are funded with loans backed by the Small Business Administration. In the UK, buyers use bank term loans, asset finance against equipment and specialist acquisition lenders. Terms change, so speak to a broker or lender early and build the offer around what can really be borrowed.

Debt magnifies everything. It raises your return when the business performs and removes your room for error when it does not. Test the deal against a bad year. If profit fell by a quarter, could the business still meet its repayments and pay you a wage? If not, the deal carries too much debt.

Investors

A buyer can bring in partners who put up cash for a share of the company. This is where buying businesses and angel investing meet: some investors prefer to back an operator acquiring an established, profitable business over a young company with no profit yet.

Investors expect a clear agreement on who decides what, how profits are shared and how they eventually get their money out. Settle that on paper before the purchase, not after.

A worked example

A business earns £150,000 a year for its owner and the price is agreed at £450,000. One way it might be paid:

• £90,000 from the buyer's own cash
• £225,000 from a lender, repaid over several years
• £135,000 deferred to the seller over three years

The seller receives £315,000 on completion and the rest in instalments. The buyer has put in a fifth of the price. Whether it is a good deal depends on one question: after the loan repayments, the seller's instalments and a fair wage for the buyer, is there still a margin of safety? The numbers are for illustration only. Every real deal is settled by its own figures.

The point

Structure is not a trick for buying what you cannot afford. It is how risk is shared between the people in the deal. When each party carries the risk they are best placed to judge, deals hold together. When one party carries none, be careful, especially if that party is you.