Most banks are reluctant to issue small loans for business purchase because they yield less interests. If you also consider the numerous requirements a bank will expect you to meet, you may quickly want to forget about taking a bank loan for your business acquisition. You will have to weigh the benefits and demerits of using your bank for a business loan before making a final decision.
Reasons Why You Should Avoid Using Your Bank for a Business Loan
Aside from your personal savings, banks are the main source of business acquisition finance. Banks will normally accept hard assets, including houses, equipment, and vehicles as collateral against business acquisition loans.
The side effects of using your property, such as house or vehicle as collateral for loans is that the bank will acquire them if you default on repayment of the loan. What even makes this issue worse is that banks will normally under-value your assets because they are afraid that the business inventories and receivables may be converted to cash to cover the operational losses of the business.
Banks want to protect the hard assets used as collateral for business acquisition loans, they want the assurance that the business buyer will not convert the inventories and receivables into cash to cover operational losses especially when the business enter a financial crisis.
Another reason to be skeptical about bank business loan for business purchase is that there are so many requirements to meet in order to qualify for such loan and unfortunately, you may not meet all of these. Most banks will request for the following before they offer you a business acquisition loan;
- Business plan (including information on product, marketing, business team and financials)
- All business financial details (Current and past loans already incurred and paid off, tax ID numbers, and standards summary).
- Details of account receivables (including payment history, and sales)
- Details of account payable (Including credit references)
- Audited and reviewed financial statements (Your balance sheet will be reviewed by the bank. They want to see assets, collaterals, capitals and the profit and loss statements for the last 3 years).
- Personal financial details (including credit and debit cards, asset and liability details, and investment accounts)
- Proof of Insurance (Banks want to ensure that your business is insured against risks)
- The copies of your past returns (The bank wants to see the corporate tax returns of your business)
- The agreements on future ratios (These include key ratios, current ration and debt to equity ratio).
Banks are not really concerned about the high-profit potentials the business has, they are only interested in the business’ ability to cover the repayment of the capital and interest on loans. If you are acquiring a small business, the bank wants you to conduct all your financial dealings through its banking institution.
If you can’t show proof of at least 2-3 years of continuous profit from the business you want to purchase, then the bank may not approve the loan. Similarly, most banks wouldn’t approve loans in amounts that exceed 50% of the business’ acquisition and that could be a huge disadvantage.
Benefits of Using Your Bank for a Business Loan
Despite all the demerits of using your bank for a business loan, there are still some very good reasons why you should consider your bank for business acquisition loans.
Perhaps the number one reason you should consider your bank for business acquisition loan is that you keep total control of the business. The bank will loan you money to buy a business based on the value of the business and your ability to repay the loan in full. Unlike equity finance options of business acquisition where the financier gets a stake in the business, especially when you are unable to repay the loan banks will not take over your collateral or asset if you don’t default in your regular repayment.
For this reason, you will surely have complete control over the management of the business and you don’t have to worry about external interference.
The Interests on Bank Loans are Tax-deductible
The interests you pay on taking bank loans is tax-deductible. Fixed rate loans from banks for business acquisition, are particularly are the best bank loans you should consider because the loan servicing payments will remain the same throughout the duration of the loan. Even if the bank loan comes with an adjustable rate feature, you will still enjoy a tax-free interest rate on the loan payment which can save you more money in the long run.
Bank Loans for Business Acquisitions are Temporary
Once you have paid off your business loan plus the interest, there are no other obligations or any involvement with bank lender unless you want to take new, subsequent loans. When you compare this benefit to equity financing for Business Purchase, you will have to pay dividends to your shareholders as long as your business exists. Equity financing will deplete your revenue because you are not the sole beneficiary of the profits.
Now that you are aware of the merits and demerits of using your bank for a business loan, you may want to take your time to compare bank loan opportunities with other forms of business acquisition financing. The primary reason why most people don’t qualify for bank loans to purchase a business is that they do not meet most of the requirements on such loans. The bank will always scrutinize past financial records and the performance of the business before considering a loan approval.
Default in the repayment of past loans can raise a red flag for most banks because it clearly shows that the loan applicant may not repay the new bank loan.
While equity finance for business purchases may attract zero interest, you are obliged to pay the equity owners a significant portion of your profit on a regular basis. Though Equity finance for business acquisition may be a better option, in the beginning, it can be a huge burden on you in the long run if the business struggles to survive.