Small Business Success: How Much Can You Afford?
If you’re thinking of buying a business and you’re probably already wondering how am I going to afford that transaction? And whether or not you are buying a franchise, starting your own business or taking an existing business and trying to prove 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’s the size of the project you can take on?
Now a bank will typically underwrite you based on what we call the 5 Cs. The 5 Cs are cash, credit, collateral, capacity and character. But for today’s video, we’re going to focus on cash flow. Now there are three primary ways people get their cash and the cash being for the down payment. The first will be just the general checking and savings account. They’ve accumulated some money over time and they are willing to use that as a down payment.
The second would be selling securities. Money that they’ve socked away in stocks bonds and mutual funds. But they’re willing to sell in order to buy this business. And then the third is rollovers for business startups, a top that we’ve talked about in other videos around how people can utilize up to 100% of their retirement assets to invest in a small business or franchise without taking a taxable distribution. And this can be used as a down payment.
Now let’s assume that you’ve got $75,000 and you believe you can use as a down payment for a business. The question is; what can I afford? If you’re starting a business from scratch or maybe a new franchise of worth, then the general rule of thumb is that the bank is going to require approximately 25 to 30% down payment. So it’s good 30% to be conservative for this example. If you’ve got $75,000, all you have to do is divide that by .30 or 30%. And that will come up 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 start startup, it’s conservative to assume especially if you’ve got good credit and you can afford about $250,000 a 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, I would just divide that by 20% because there’s history in the business. Generally the banks will be more friendly in terms of how they monitor it. And so really you can divide that same number by 20% 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 I afford?” as you go out and search for the right business for you.