Whether you’re looking into buying a franchise, an existing business or starting a new business, you’re likely beginning to research how much you can afford to spend. Your project budget is one of the pillars of your business plan and is often a point of confusion for new business owners. To help entrepreneurs better understand what size of a project is feasible, David Nilssen, CEO and co-founder of Guidant Financial discusses simple ways to understand how much you can afford.
Learn more about how to budget for your small business in our most recent video installment of the Small Business Success series.
No time for a quick video? Here’s the transcript:
David Nilssen: If you’re thinking of buying a business, you’re probably already wondering, “how am I going to afford that transaction.” Whether you’re buying a franchise, starting your own business, or taking in an existing business and trying to grow with that, it really doesn’t matter in terms of financing.
What we’re going to talk about today is, general rules of thumb that can help you determine, what is the size of the project you can take on. A bank will typically rate you based on what we call the five C’s, and the five C’s are: cash, credit, collateral, capacity and character. But for today’s video, we’re going to focus on cash or loan.
Now there are primarily three ways that people get their cash and the cash being for the down payment. The first one being, just the general checking of your savings account. They’ve accumulated some money over time, and they’re willing to use that as a down payment.
The second would be selling securities, money that they’ve stocked away in stocks, bonds and mutual funds that they’re willing to sell in order to buy this business.
Then the third is Rollover for Business Start-ups. We’ve talked about in other videos, how people can utilize that to 100 percent of their retirement assets to invest in a small business or franchise without taking a taxable distribution. This can be used as a down payment.
Let’s assume that you’ve got $75,000, and you believe that you can use as a down payment for a business, but the question is, what can that afford you? If you’re starting a new business from scratch or maybe a new franchise, then the general rule of the thumb is that the bank is going to require approximately 25 percent, 30 percent down payment.
So, let’s go with 30 percent to be conservative with this example. If you’ve got $75,000, all you have to do is divide that by .30 or 30 percent and that will come out to $250,000. That right there will estimate the total project that you can take on. So if you’ve got $75,000 and you’re going into a startup it’s conservative to assume, especially if you’ve got good credit, then you can afford about $250,000 project, or a $175,000 loan given that math.
Now, if you’re buying an existing business or you have one already, and you’re looking to recapitalize that, or purchase an existing business, then I would just divide by 20 percent. Because there’s history in the business, generally the banks will be more friendly in terms of how they loan to it. So really you can divide that same number by 20 percent, and it changes the project cost from $250,000 to $300,000 itself.
That’s a good general rule of thumb to help you understand, what can you afford as you go on and search for the right business for you.