You have decided that you want to buy a business, now you need to determine what type of business do you want to purchase and what size of business do you want to buy. The size of business will be dependent on the amount of equity that you have and the type of business that you are buying. Often, banks will not lend to a buyer of a business money for a retail store. There are government lending programs which will allow you to finance leasehold improvements and equipment but there is little, if any money available for finance inventory of a retail stores in Canada unless you are a large corporation. The amount of money that the banks will lend an individual is based on their other assets which they own personally and not on the assets of the retail store.
Manufacturing companies, on the other hand, have lots of equipment and own the right/patent to make a specific product. As a result, they are often capital intensive but because the assets are bricks and motor as the banks describe it – tangible assets, the banks will lend more money to a manufacturing company than they will any other type of business.
Banks will provide wholesale companies financing but will limit the amount of money for inventory. In Canada, the Bankruptcy Act allows suppliers who sell goods to a business to repossess goods if they were sold to the Company within 30 days of going bankrupt. As a result, a third party has priority reclaim to the Company’s inventory before the bank can claim their collateral. Please contact your lawyer to find out the exact rules but this is a very general overview of the rules. Since the bank is not in priority, they will not lend as much money to you because they do not have a lot of security if you turn your inventory very quickly. Banks will tend to provide a line of credit based on your accounts receivable.
According to a few bank friends of mine, a rule of thumb that some bankers use is your operating line should be 10% of your sales. Many banks lend 75% against accounts receivable and up to 50% for inventory. On average this will work out to be 10% of your sales. This is the standard concept used for manufacturing and wholesalers for operating line of credit. Once you have the operating line, you also need additional funds for financing the acquisition. Depending on the assets you may be able to use some of the assets of the business to be used to secure your acquisition financing but the majority may have to come from your own person resources.
How big should the company be that you buy? The larger the company, the greater the cash flow and the more expensive the purchase price. If the company is larger, you may end up with having staff to do part of the work for you. If it is large enough, there will be management to operate the day to day operations of the business and you would be the CEO and guiding light of the business.
The question will be what do you want to do? Do you want to be the operator, do you want to do all the work, do you want to work 7 days per week, 5 days per week or 3 days per week? Do you want to be able to take vacations or are you going to be married to the business? The larger the business the less that you will have to be doing on a day to day basis, you can be the over seer and you can be the strategic mind in the business.
There is no right and wrong, it all depends on how much money you have to purchase a business. The larger the business, there may be less risks because the business may be more diversified and less reliant on the owner therefore there may be a greater likelihood that a change in ownership will have little or no impact on the revenue of the business because businesses are dealing with the company and not there only because of a personal relationship with the old owner.