How to calculate if a business can afford loan repayments taken on for a business acquisition?

[NKUK]

A question related to buying a business. If part of the business acquisition involves taking on some sort of loan/debt, e.g. asset based lending, seller finance (deferred consideration) etc or a combination of these, how do you calculate if the business can afford to pay the loan repayments? Is there a simple formula to be able to determine this?

What do I need to be looking at in the business to determine it's ability to pay back loans - is it the net profit, EBITDA, free cashflow, DCSR (debt service coverage ratio)? Presumably I'd need to do a 5 year cashflow forecast too (for showing to lenders etc)?

I'm not any sort of formally trained accountant, though I've taught myself the fundamentals of accounting and bookkeeping and can read financial statements.

Some might say, 'just hire a qualified accountant' to determine whether a potential business acquisition will be able to afford any debt repayments. Sounds good in theory but the problem is, I look at around 10 to 20 potential deals a week, so it would get extremely expensive to have to pay an accountant to look at every deal upfront only to tell me 'nope, that deal won't work because the business won't be able to pay back the debt taken on'.


I don't want to bring in an accountant at the initial stage of looking at a deals for this reason. I am happy to bring in an accountant later on (after heads of terms is signed with the business owner) in order to do the deeper financial due diligence and AFTER I've worked out that yes the business can afford the debt repayments.

To give some info, seller finance (deferred consideration) and asset based lending asset typically paid back over 5 years . So is there a simple formula I can use to work out if the business will be able to afford the debt repayments (as well as all its other expenses, including paying me a decent salary)?


Should I work backwards and adding a decent amount of seller finance (deferred consideration) @ 7% interest or on an earn out basis if possible (no interest and % linked to profit) and then see how much I need to raise and then work that out at lending rates? I'd presume that if the debt is not affordable then I'd need to negotiate and reduce the asking price of the business acquisition and / or bring in an equity partner.

Thanks.

 

[Mark T Jones]

To the best f my knowledge there is no set formula, lenders will look to various degrees at historic cashflow, future projections and the underlying assets.

Yes, you need to do (researched ) projections- primarily for you.

 

[numbersrule]

It depends if the post-purchase entity will have different financial metrics to the pre-purchase entity or entities.
if yes, then looking at existing available metrics may not help much.
This is why there are no set formulas.
But it sounds like you do a lot of this sort of stuff so you will know that every deal is different and has it's own unique characteristics.
Reducing to formulaic criteria may not be In your best interests.

 

[fisicx]

When I did my degree one of the modules was mathematical modelling. It’s complicated and difficult to set up the model. It also needs constant adjustment and refining.

You need to start with a number of axioms and then develop a set of equations that may use probability theory, calculus and so on.

The one we created as part of the course had over 40 different variables and would take the best part of a day to come up with a solution.

So yes @NKUK - you can do what you want but you probably need to pay a mathematician to help build the model.

 

[Clinton]

...how do you calculate if the business can afford to pay the loan repayments? Is there a simple formula to be able to determine this?

If you don't know how to do that, stick to the day job.

But it sounds like you do a lot of this sort of stuff ...

No, I don't think s/he does. The OP sounds like someone who attended a course on how to buy a business with no (or almost no) money down and who now fancies themselves as a business tycoon who's going to become the next Elon Musk.

Here's some background: If you're dealing in 8 figure deals (my typical client), there's all kind of deal structuring that comes into play like the aforementioned asset financing, convertible notes, warrants etc etc.

If you're playing in that field, you'll have at least one super savvy CFO / corporate finance expert on your payroll. This kind of calculation is what they do in their sleep.

The smaller the deal, the more likely it's going to be an all cash deal. If you buy a market stall for £5K, all your fancy asset finance bullsh*t ain't going to work.

Move up to a £50K business and the owner is still likely to demand all cash or mostly cash (with, maybe, a small portion of deferred payments). Asset financers, M&A finance companies are not going to even look at those silly numbers. It just isn't big enough for them to get involved.

Move up to £5m EV and you could get some financing, but you're going to have to show a serious investment of your own money, maybe £1m+

Skin in the game and all that.

The OP seems like one of those thousands of suckers who attended a Jonathan Jay / Carl Allen / Codi Sanchez kinda course and got fooled into thinking they could bring all that "financial engineering" complication into a micro deal.

Unfortunately, and from what I've seen in the past, it takes them a year or two to realise that this just isn't going to happen.

 

[Mark T Jones]

Move up to a £50K business and the owner is still likely to demand all cash or mostly cash (with, maybe, a small portion of deferred payments). Asset financers, M&A finance companies are not going to even look at those silly numbers. It just isn't big enough for them to get involved.

Not the 'proper' M& A, but you can get get finance.

Back when I was in the 'all types of finance' game I did a few, essentially splitting between loans, asset & invoice.

It's actually part of the reason why I chose to get into a proper, proactive niche - because unfortunately, more often than not, it really was just getting people into debt...

 

[Clinton]

Back when I was in the 'all types of finance' game I did a few, essentially splitting between loans, asset & invoice.

PG backed?

 

[Mark T Jones]

PG backed?

Oh yes!

 

[Clinton]

Ah, I bet they don't tell you that in the Business Acquisition Course

 

[Mark T Jones]

Ah, I bet they don't tell you that in the Business Acquisition Course

It's always a revealing conversation

 

[Clinton]

Mark, I'd love to be a fly on the wall when you're having those conversations.

For anyone else reading the thread, you don't bring in an accountant AFTER signing heads of terms, as the OP proposes to do.

You get a good accountant in BEFORE formally agreeing the deal. Here's the kicker: you ideally need to ALSO bring an M&A lawyer in before signing heads of terms.

While the HoT isn't binding (except for provisions on confidentiality etc), the HoT forms the basis for the final contract - the Share Purchase Agreement (SPA). It's crazy to agree a HoT and then hire a lawyer to draw up the SPA as the lawyer will find all kinds of flaws with the HoT.

It always amazes me that business owners who can't do basic M&A calculations, and are therefore not M&A savvy, think they have the smarts to negotiate and agree an M&A contract themselves.

People who think buying a business is easy (or cheap) are in for a surprise.

70% of deals fail after HoT. For a buyer, that means he may have spent £10K+ on professional fees and has a 70% chance of losing all that money (when/if the deal doesn't proceed to completion).

He then starts again and pays another £10K or £20K. That's normal!

They probably don't teach this in the Jeremy Harbour and other courses.

Deal sourcing is expensive.

Getting professional advice on prospective deals is expensive.

Due diligence costs an arm and leg.

Paying the seller a chunk of readies on the day of completion also takes having some readies.

Buying a business generally requires one to start with having some money in the bank. Crazy, I know.

I bet all of you are most surprised by this!

 

[NKUK]

Mark, I'd love to be a fly on the wall when you're having those conversations.

For anyone else reading the thread, you don't bring in an accountant AFTER signing heads of terms, as the OP proposes to do.

You get a good accountant in BEFORE formally agreeing the deal. Here's the kicker: you ideally need to ALSO bring an M&A lawyer in before signing heads of terms.

Absolutely NOT!!! You don't need to bring in your lawyer or accountant before signing Heads of Terms!!!! Doing so is incredibly inefficient and costly, especially if you look at a large number of deals each week or month, since not every deal you look at will end up closing. So if you were to pay an accountant and lawyer upfront, only for the vast majority of your deals to not complete, it's going to cost you a fortune and not be sustainable.

The smart business buyer looks at a potential acquisition and does the initial due diligence themselves, including assessing the financial side of the business to see if it's profiting sufficiently, whether it will be able to afford to service any debt taken on for the acquisition etc.

Only after you've ascertained this do you sign a Heads of Terms. If the numbers don't stack up during your initial due diligence, you move on to another deal and don't move to Heads of Terms

You only bring in the accountant and lawyer AFTER you've signed Heads of Terms (during the 90 day exclusivity period) - they do the deeper due financial and legal due diligence.

I can tell from your reply you don't know much about business buying. Please refrain from replying. Telling people to bring in a lawyer and accountant before signing Heads of Terms is STUPID.

 

[Clinton]

I can tell from your reply you don't know much about business buying.

I once read a book on buying / selling businesses. Does that not count?

 

[Paul Kelly ICHYB]

especially if you look at a large number of deals each week or month

Which most businesses do not!

@NKUK The simple calculation isn't rocket science - does the business make enough profit at the moment to cover the repayments and, if it doesn't, will any changes you implement cover those costs?

As you admit to not being a financial whiz (many of us are not, but know the basics), getting an accountant to cast their eyes over things will not only allow a proper response to your question, but also start uncovering any other skeletons lurking around. Think of it as starting the DD.

BTW, always ensure that you have a contingency fund available as, even with the best diligence and plans can sometimes not go down well!

 

[Clinton]

Getting back to serious stuff, the OP is right in that buyers looks at a potential acquisition and do the initial due diligence themselves ...except this is not called DD, it's initial vetting of target / opportunity.

Most targets can be eliminated at this stage. Either the buyer finds a major flaw or the seller has unreasonable expectations, or both.

Initial vetting involves asking questions, getting accounts / management accounts etc. If the target passes this stage, the buyer then moves to putting an outline offer together which is followed by some negotiation. An accountant may be useful at this stage if the buyer isn't a dab hand at crunching numbers (bear in mind there's stuff like working capital requirements to be calculated, EV to equity bridges, all sorts of other stuff way beyond the pay grade of someone who can't calculate free cash flow to service debt).

Once an oral agreement is reached on terms, these terms need to be drafted into a HoT which bounces between the parties till these formal terms are agreed. Unless the deal's for some throwaway money, the buyer would be a complete moron to not get a lawyer's input on the draft HoT.

AFTER you've signed Heads of Terms (during the 90 day exclusivity period) - they do the deeper due financial and legal due diligence.

No, there is no standard "90 day exclusivity". The exclusivity period, like everything else, is subject negotiation. On a small deal, I wouldn't give even half that!

If the seller is being properly advised, he'll charge the buyer a non-refundable deposit in exchange for a 'reasonable period' of exclusivity! That's a provision one needs to include in the HoT.

In a deal for a recent client of mine, the buyer was charged a £30K non-refundable deposit (to be used towards cash on completion). When the buyer didn't proceed to completion, he lost his £30K. A lawyer called Dan Johnson of Equitable Law was the guy who drafted the terms in that deal (if anyone wants to verify this). The £30K covered all of the fees the seller owed Dan and his accountant for work done on the aborted deal.

The buyer left licking his wounds.

A properly represented seller will run rings around you if you don't know what you're doing.

I've got a guide here for sellers who are dealing with assorted £1 Charlie morons and crooks rather than proper, serious buyers.

 

[NKUK]

Getting back to serious stuff, the OP is right in that buyers looks at a potential acquisition and do the initial due diligence themselves ...except this is not called DD, it's initial vetting of target / opportunity.

You could call it 'Initial vetting of target' or 'Early due diligence' - that's just semantics.

No, there is no standard "90 day exclusivity". The exclusivity period, like everything else, is subject negotiation. On a small deal, I wouldn't give even half that!

90 days is the generally accepted and most common period of exclusivity for a Heads of Terms. It can be longer or shorter in some cases depending on what the buyer and seller negotiate, but most of the time and in most business acquisitions 90 days is most common.

If the seller is being properly advised, he'll charge the buyer a non-refundable deposit in exchange for a 'reasonable period' of exclusivity! That's a provision one needs to include in the HoT.

In a deal for a recent client of mine, the buyer was charged a £30K non-refundable deposit (to be used towards cash on completion). When the buyer didn't proceed to completion, he lost his £30K. A lawyer called Dan Johnson of Equitable Law was the guy who drafted the terms in that deal (if anyone wants to verify this). The £30K covered all of the fees the seller owed Dan and his accountant for work done on the aborted deal.

Awful advice. I've never met a seller who did this, and I would not proceed with such a deal if they did. A seller would have to be extremely poorly advised to have something like that advised to them.

I do the exact opposite of this - I state in my Heads of Terms that if the seller decides to pull out of the sale, they have until a certain date (stated in the Heads of Terms) to inform me, otherwise they're liable for any costs I've incurred during the due diligence (up to an agreed amount). If they don't agree to this, I don't proceed any further with the deal. Simple.

 

[NKUK]

I've got a guide her for sellers who are dealing with assorted £1 Charlie morons and crooks rather than proper, serious buyers.

I disagree with everything in that guide, and disagree with the whole premise of it and the associated website. It's not relevant to me or this thread, so don't promote that here.

 

[Clinton]

Okay, since you asked so nicely, here's another (related) link for you: Business Acquisition Courses To Avoid.

I'll leave moderation to the moderators and shall respect if they remove any of my links for being promotional.

But I'm upset you disagree with everything I've said. Is there no way I can convince you? How about if I run a little course just for you? Say £9,997. Deal? I'll also show you the simple formula you asked for in your OP.

 

[NKUK]

I'll leave moderation to the moderators and shall respect if they remove any of my links for being promotional.

But I'm upset you disagree with everything I've said. Is there no way I can convince you? How about if I run a little course just for you? Say £9,997. Deal? I'll also show you the simple formula you asked for in your OP.

Stop hijacking my thread, taking it off on tangents that are nothing to do with my original question, and posting links to promote yourself and your agenda. Stop throwing personal insults around too.

Either answer the original question, or don't reply.

I'm going to give you one warning, and any more of this and I'll report you to the mods and have you banned from this forum. Do you understand me?

 

[NKUK]

Actually sod it - I've already reported you to the mods, so we'll see how they deal with you from here. I have no patience for posters like you.

 

[BusterBloodvessel]

you are new to UKBF, as the warning clearly shows us.

I’d suggest

A) reigning in the Billy big spuds around reporting to moderators
B) look at the credentials of some of the people that are offering you advice. It may be blunt, it may not be what you WANT to hear. But it’s almost certainly stuff you SHOULD hear.

 

[Mark T Jones]

3 things you need to learn before you go into the real world of business

1. Sometimes the best advice isn't delivered with a hug ,and is what you don't want to hear

2. Frequently the advice you like is given by people who want to relieve you of money, not to help you.

3. Running to teacher won't work. Unless they have committed an actual offence, you are on your own.

 

[NKUK]

you are new to UKBF, as the warning clearly shows us.

I’d suggest

A) reigning in the Billy big spuds around reporting to moderators

I'm pretty sure it's against the rules of this forum to hurl around insults, take threads off on tangents and to promote your own business links here.

B) look at the credentials of some of the people that are offering you advice. It may be blunt, it may not be what you WANT to hear. But it’s almost certainly stuff you SHOULD hear.

I looked at this guy's advice - it was an absolute joke, and he's a business broker, so enough said. He has an agenda to push which is not true and not helpful. That and the tone of his advice is very arrogant, childish and condescending.

I'm well aware of most of the ins and out of buying businesses, but there are few bits I needed help with, hence why I asked the original question. The poster 'Clinton' did not answer my question, but chose to hijack the thread to promote his own agenda and bias about business acquisitions. He also did so in a manner that was personally insulting and childish.

So you had better get used to me being here. Let me warn anyone who thinks they can insult me or push me around. I am no pushover and if people like 'Clinton' are going to say and do stuff like this on mine or other peoples' threads, then rest assured I won't stand for it. I will fire back and I will report to the mods if necessary.

 

[BubbaWY]

I'm going to give you one warning, and any more of this and I'll report you to the mods and have you banned from this forum. Do you understand me?

Wow

 

[Clinton]

I'm not a business broker

I'm well aware of most of the ins and out of buying businesses...

Respect!

How many have you bought?

 

[Mark T Jones]

I'm pretty sure it's against the rules of this forum to hurl around insults, take threads off on tangents and to promote your own business links here.



I looked at this guy's advice - it was an absolute joke, and he's a business broker, so enough said. He has an agenda to push which is not true and not helpful. That and the tone of his advice is very arrogant, childish and condescending.

I'm well aware of most of the ins and out of buying businesses, but there are few bits I needed help with, hence why I asked the original question. The poster 'Clinton' did not answer my question, but chose to hijack the thread to promote his own agenda and bias about business acquisitions. He also did so in a manner that was personally insulting and childish.

So you had better get used to me being here. Let me warn anyone who thinks they can insult me or push me around. I am no pushover and if people like 'Clinton' are going to say and do stuff like this on mine or other peoples' threads, then rest assured I won't stand for it. I will fire back and I will report to the mods if necessary.

Let's take it out of the playground - this is a business forum after all.

You may not like the way Clinton delivers advice - many don't - but be assured that he does know his stuff on the topic of M & A. You don't have to agree or follow, but you'd be foolish not to listen.

I was aware of these 'get rich' business buying courses well before I'd heard the term 'one-pound Charlie's' or Jonathan Jay and quickly got a feel for the people they churned out. Unfortunately you appear to be the stereotype product of the courses (a victim of duff advice and blind optimism)

Stay around, join in learn & contribute - but drop the silly playground threats, it's not a good look in business.

 

[Ozzy]

I'm going to give you one warning, and any more of this and I'll report you to the mods and have you banned from this forum. Do you understand me?

OK, just to confirm, I decide who is banned from this forum no one else.

Actually sod it - I've already reported you to the mods, so we'll see how they deal with you from here. I have no patience for posters like you.

Normally, reports are kept private and dealt with in private, but as you posted in this thread, I can reply.

@Clinton will and has openly said on here, he and I often do not see eye to eye and have had our spats. Just because I don't like the way he puts his message across sometimes, doesn't mean I don't respect his knowledge and experience. I've tweaked a couple of his posts to tone them down, as I have done a few times on this forum. Doesn't mean his advice isn't sound.

I have also deleted a handful or off-topic posts just to keep the thread on track whilst I was brought here.

Absolutely NOT!!! You don't need to bring in your lawyer or accountant before signing Heads of Terms!!!!

I have sold 7x of my businesses in my time, and I've bought a couple, and I would never proceed past the initial tyre kicking without having my legal and tax advisers in place and up to speed. Yes it may slow things down, yes it may cost money, but that is what my experience has taught me after I sold my first business without having them there and lost everything.

We don't all have to agree on everything, neither do we have to be cuddly and sing round the camp fire, but I'd always encourage everyone to take on all advice and feedback as sometimes it may be spot on even if you don't want to hear it.

 

[Clinton]

The OP seems to have abandoned the thread. That, combined with @Ozzy 's post above, means I cannot look forward to singing around the camp fire with the delightful @NKUK

I get all the "this is a new poster, be kind" stuff, but between posters with a chip on the shoulder and completely clueless ones, it's bloody difficult. When I ran forums, I took it as my job to maintain quality of new members. There is no such filter here so any ol' muppet can sign up and post any ol' sh*t.

And we don't know the sheer level of plonker-ness till we engage and they start replying!

I'm going to start an online petition that anyone looking to sign up to any forum has to first pass some tests of basic intelligence

They should be exported on dighies to France if they fail. Or point the dinghy to Rwanda if they fail and they happen to look ugly as well.

 

[Newchodge]

I'm going to start an online petition that anyone looking to sign up to any forum has to first pass some tests of basic intelligence

That's a great idea. I assume you would also accept some tests of basic manners?

 

[Clinton]

Nah, posters like the OP are still welcome IF they pass the intelligence test.

 

[Mark T Jones]

The OP seems to have abandoned the thread. That, combined with @Ozzy 's post above, means I cannot look forward to singing around the camp fire with the delightful @NKUK

I get all the "this is a new poster, be kind" stuff, but between posters with a chip on the shoulder and completely clueless ones, it's bloody difficult. When I ran forums, I took it as my job to maintain quality of new members. There is no such filter here so any ol' muppet can sign up and post any ol' sh*t.

And we don't know the sheer level of plonker-ness till we engage and they start replying!

I'm going to start an online petition that anyone looking to sign up to any forum has to first pass some tests of basic intelligence

They should be exported on dighies to France if they fail. Or point the dinghy to Rwanda if they fail and they happen to look ugly as well.

Serious note

I support 100% the notion that there is no such thing as a stupid question. Far better to see a newbie asking what might appear obvious than letting them dive in blind

On the other hand, there are stupid reactions to the information given, which are typified by

- cozy up to anyone who says what you want to hear

- ignore or attack anyone who says what you don't want to hear.

(Often followed by a post slating the forum as a whole)

I lose interest at the point where it becomes obvious they are after hugs rather than advice

 

[Clinton]

I support 100% the notion that there is no such thing as a stupid question.

One example of a stupid question is a question asked in a short thread when it has already been answered in that very thread.

Then there are questions that include ridiculous hypothetical assumptions.

Questions asked purely to troll.

I could go on.

We shall have to agree to disagree on this.