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Equity Equity is the term used by financiers to describe the capital invested in the business by the business owners from their own resources. The advantage to the business of equity is that there is no interest charge, and a return is only paid to the investors if the business is generating money (no duck - no dinner!). For the single person or couple buying a small business on their own, there are really only two sources of equity:
* Funds from personal wealth.
* Profits generated by the business after takeover (which are obviously not available to fund the initial purchase of the business, but can contribute to financing expansion further down the road).
As we shall see when we discuss debt, because equity is free to the business, providers of debt finance like to see a reasonable amount of financial commitment from the business owners. If you are short of funds, it may be necessary to seek additional investors to provide equity to top up yours, possibly by bringing in a business partner.
Debt There are various types of debt, some general in nature, and some tailored to a particular purpose. It is important for the ongoing health of the business to ensure that it is funded appropriately. Providers of debt finance like to see a reasonable financial investment contributed by the owners of the business. This is because:
* They do not like to take all the risk - if the owner has no money at stake he could walk with impunity at the first sign of trouble.
* Equity money is free - as already stated, equity investors get nothing unless the business generates money.
* In the case of insolvency the debt is paid back before equity.
Lenders describe the relationship between debt and equity as the 'debt to equity ratio' or 'gearing'.
If you buy a business for $100,000, borrowing $75,000 and paying $25,000 from your own savings, the debt to equity ratio (or gearing) is 3:1.
Different lenders look to different maximums for the debt to equity ratio, often setting separate criteria for each type of transaction. In calculating the ratio they include all sources of debt, not just their own. The other main consideration for lenders is the available profit to service the debt, often referred to as 'interest coverage' or 'debt service ratio'. If they consider that the forecast profit is too low in relation to the anticipated level of interest and repayments, they will not lend. There are many different types of debt, and only some will probably be relevant to your case.
There are following types of debt finance:
General - Term loans.
- Overdrafts.
- Business cards.
- Government Loan Guarantee Scheme.
- Trade creditors.
Asset linked - Invoice finance {for businesses that sell on credit).
- Vehicle finance.
- Commercial mortgages (for business property).
- Plant and equipment finance.
- Leasing (for vehicles or equipment)
Grants Grants are generally only made available for encouraging investment in new business projects in areas of the country where unemployment is a major problem, or in particular industries that it is in the public interest to encourage - solar energy, for example. If you are buying an existing business it is highly unlikely that you will be eligible for grants, and it is beyond the remit of this book to provide information on the myriad schemes that are available. However, if you think what you are doing could be eligible for such assistance you should contact your local Business Link who will guide you in the right direction.
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