Shall We Buy Business with Cash or Loan

brownbag on 01/11/2018 - 14:28

I got my answer in https://www.ozbargain.com.au/node/412278 (“What Taxes do small retail businesses pay”) and there are no taxes (other than GST which is already charged to the customer so doesn’t affect my figures.
I now need to decide if I should lend the money to buy the business. The cost is small and including other (mostly optional) costs, is only around $40000. We have that in the bank and can buy it outright or lend the money.
The question I have is, is it better in general to buy the business with a bank loan, or to use cash. From my point of view, I see the following pros/cons of the bank loan:
PRO - I will have more spare cash available for future investments, such as investment properties, etc
PRO - interest is tax-deductible and
CON - admin fees to get loan are significant on a small loan
CON - Gross cost is higher - I'll pay a higher interest rate on the money with a loan than what I get from the bank with my money.
CON – A loan does affect our credit rating, so reduces our options with possible other investment loans

In pure cash terms, we’re better off by $450 -$500 a year buying the business in cash, but is there something else other than the above that should also be considered?

Poll Options expired

  • 7
    cash
  • 31
    loan
Financial

Comments

  • pantsparty on 01/11/2018 - 14:35
    +1

    Why would you spend money to buy a business which you said will never make a profit?

    • brownbag on 01/11/2018 - 14:38

      It will make a good wage for my wife.

    • HighAndDry on 01/11/2018 - 14:42

      The business won't make a profit. I'm assuming OP and wife will be drawing a salary from the business from working in it though.

      • brownbag on 01/11/2018 - 14:43

        Just my wife - she'll be a sole trader, as is the current owner. I won't draw a salary.

        • HighAndDry on 01/11/2018 - 15:34
          +3

          Fair enough. I don't know what kind of small business it is, but just be sure to know what running it involves. I think you said below that you wife knows the business well, so I think it should be okay, but I see a lot of people going into these kinds of businesses and realising afterwards that what looks like an easy gig is actually a 70hr/week commitment.

          • brownbag on 01/11/2018 - 15:45
            +1

            @HighAndDry: It's a retail shop. I know it seems odd that a business can be less stressful than a job, but this one really is like that. It's a shop without any stock. People actually come to the shop to provide goods to sell on commission. They get so many goods offered that they have to knock people back.

            • HighAndDry on 01/11/2018 - 15:48

              @brownbag: Oh wow, that's a nice situation to be in.

            • SBOB on 02/11/2018 - 07:39
              +5

              @brownbag:

              People actually come to the shop to provide goods to sell on commission

              Is there a tv/electronics store across the road with a 40 year old virgin working there?

              • Flanders on 02/11/2018 - 18:49

                @SBOB: He was 40 in 2005,
                53 yo virgin now .

  • [Deactivated] on 01/11/2018 - 14:36
    +9

    If you can get a loan with the business as the security, loan.

    It's best to have the business as divorced from your personal finances as possible.

    • Scrooge McDuck on 01/11/2018 - 14:52
      +1

      And if the post-deduction/effective interest on the loan is less than the return of what you could otherwise invest the capital in, the loan is more economical.

      • brownbag on 01/11/2018 - 14:57

        Thanks. I think I'd have to find a different reason for a loan than just the effective interest, especially because in this climate (with inflated asset prices) the only safe other investment is cash, which doesn't return much. Then again, in a few years, I may feel that I'd be better off having the cash to invest in something else.
        The effective interest on the loan is much more than the 'effective interest' on cash. So the interest on the loan would be higher. I'm looking for other reasons to get a loan, and it seems that the three I can find so far are:
        1. cash flow
        2. separation of finances
        3. possible future investment possibilties

        • Seraphin7 on 01/11/2018 - 15:44

          The probabilites are that a loan with the business as security won't be approved. Most providers of "business loans" will want property (often residential property) as security and therefore it just becomes a home loan for most people.

  • GG57 on 01/11/2018 - 14:36
    +4

    Extract from the previous discussion:
    For what it's worth, the vast majority of people who purchase a business in the manner you've described (i.e. purchasing a business you have no familiarity with behind the scenes) will purchase it in their own name or entity rather than buying out the seller's shares in the trading company. You should get some legal and financial advice before committing to this course of action

    So when you get that legal and financial advice, include in it how you can potentially fund the purchase, as it will have implications on how that 'works' with the structure of your business.

    • bigballerbrand on 01/11/2018 - 14:38
      -5

      don't even bother. this guy has enough money to say $40k isnt a big amount, he also has it in cash in the bank, yet hasn't gone to have an initial discussion with an accountant first.

      • brownbag on 01/11/2018 - 14:40
        +6

        Hang on, who says that I'm not going to see my accountant - all the due diligence will be done and I may even get financial advice on this. I've just got some time on my hands and I'm doing some background research on this question first, on the basis that it's likely that we'll go ahead.
        So why would you say something so rude and dismissive?

      • brownbag on 01/11/2018 - 14:43
        +2

        It's not about how much money I have - successful businesses such as this generally cost way over 40k. This isn't a big amount for anyone wanting to buy a business.

    • brownbag on 01/11/2018 - 14:39

      There is no company - it's just a sole tradership. Yes, our accountant is going to look through the books and assess it first but my initial detailed assessment suggests that it is worth buying.

      • bigballerbrand on 01/11/2018 - 14:43
        +3

        I can tell you that your accountant can't assess the viability of the business. They will know as much as you know. They will see income and expenses. and cash flow. thats about it.

        What your accountant can give you, is advice on what structure to use, the tax effectiveness of structures, and the asset protection or lack there of afforded by each structure.

        • suntap on 02/11/2018 - 12:05

          cash flow is king and is what makes a business viable. An accountant can certainly give you great advice on the viability of a business.

      • GG57 on 01/11/2018 - 14:44
        +1

        Again from the previous forum:
        We're buying the business as a going concern so it will remain as a company…
        The books are hard to fudge as they are all in paper

        And now there is no company? What is a 'sole tradership'?

        Seriously, I'm not sure why you are posting these forums as it is all sounding more like BS every post.

        • brownbag on 01/11/2018 - 14:47

          I discovered, in my investigations, that there's no company structure and that the owner is a sole trader. I can't remember who mentioned going concern first, but I went along with it just to indicate that no change was taking place - maybe my terminology wasn't good then.

          But if you don't know what a sole trader is, maybe you're not the best person to have input into this.

          Do you think I'm making all this up? Really? ?????

          • GG57 on 01/11/2018 - 15:04

            @brownbag: I know what a sole trader is, and I know what a sole proprietor is; perhaps a terminology issue as well?

            So my advice from earlier stands, when you do get around to seeing your accountant, ask them the best way to structure your financing, as it will have implications.

            As said elsewhere in this forum, at the very least you need to separate personal from business finances.

        • bigballerbrand on 01/11/2018 - 14:49

          Sadly its the case with most people that buy businesses. Actually most people are better off because even though they may not know the financial side, they are usually experts in the field they are buying the business. This guy is neither. Which doesn't bode well.

          But I do wish him the best. I support local businesses as much as I can with my spending. If he does his research and knows what he is getting into, then it may work out.

          • brownbag on 01/11/2018 - 14:54

            @bigballerbrand: It's my wife buying a business and it is extremely small and successful business run by a 70 year old.

            In this case, my wife knows the business well, and I will have no problem (at all) helping her manage the financial side. It's successful right now and my wife will make money from day 1. So it bodes very well in fact.

            Yes, I've got a bit to learn as we've never run a business, but this is about as simple a business as you can get.

            And although I've never run a business, I am actually quite a lot more cluey than you may imagine.

            • bigballerbrand on 01/11/2018 - 14:57
              +1

              @brownbag: No disrespect, apologies if it came across that way.

              I am merely playing devils advocate as I like to make sure people know what they are getting into when they go into business. I have been a tax agent with my own business for 20 years

  • HighAndDry on 01/11/2018 - 14:43
    +2

    Loan - because for small businesses, cashflow is king.

  • TheBilly on 01/11/2018 - 15:07
    +1

    Why would you buy a business to draw a wage? Why not just get a job? why not just start a new business yourself? … I'm not asking condesendingly, I'm just genuinely curious.

    • bigballerbrand on 01/11/2018 - 15:11
      +2

      Not to speak for him, but now that I know more about the situation …. if the old lady is retiring, you are essentially buying the goodwill of the business, and the existing machinery, fitout and everything that comes along with it. Normally, doing this stuff would cost way more than $40,000 anyway so as long as the business makes enough money to cover his wife's drawings, then it seems like a good idea.

      • brownbag on 01/11/2018 - 15:30
        +1

        yes, that is correct. thanks.

      • brownbag on 01/11/2018 - 15:32

        I'd say that the major 'component' of the business price is the goodwill. It is extremely popular for a small shop. that makes it quite valuable. In fact, a lot of people will be very relieved to know that it is being sold and not just shut down.

    • brownbag on 01/11/2018 - 15:29
      +2

      A few reasons. It is my wife who is buying the business.
      She has an auto-immune disease and can't work full time. This business is open about 30 hours a week, so part-time. I can do the back-end stuff (book-keeping etc) so my wife doesn't have to stress about that.
      It is a low-stress business (believe it or not) and much lower stress than her last job.
      The business also allows her to express her creativity.
      The business is already successful - it will enable her to earn roughly $70000 a year working part time, and maybe expand it to earn even more.

      • TheBilly on 01/11/2018 - 15:32
        +1

        Makes sense now !!

      • HighAndDry on 01/11/2018 - 15:38

        It is a low-stress business (believe it or not)

        Good catch, because "small business" and "low stress" almost never go together. But if you won't be depending much on the income from this business, and there aren't a lot of initial outlay (or stock-in-trade, etc) involved then I guess it could be.

        In addition to my comment further up, because you said it's a creativity thing, just be ware that while you are buying goodwill, a lot of small businesses have the actual goodwill tied up with the owner/proprietor which won't really transfer over readily. Depending on how big a component that is, I'd be conservative with how much income you can expect to derive from the business at the outset.

        Best of luck to you and your wife though!

        • brownbag on 01/11/2018 - 15:48
          +1

          Yes, there's no outlay as there is no stock to buy at all. You make a good point on good will there. But you don't know my wife. She'll only increase the goodwill. :)

          • HighAndDry on 01/11/2018 - 15:50
            +1

            @brownbag: If this is the case, I might actually change my vote from "Loan" to "cash" because it seems like it'd be unlikely you'd be faced with any sudden/serious cashflow issues. Not having the loan would then spare you the worry of meeting those loan servicing costs, in addition to obviously interest and all the other costs and fees associated with it.

      • serpserpserp on 02/11/2018 - 20:09
        +1

        Who sells a business for 40k that can pay an employee 70k p.a to work part time? Crazy good deal there.

        Why not employ someone for 50k to work full time in the business and take the rest as profits?

        • tryagain on 03/11/2018 - 03:02

          A 70yr old by the sound of it, would make sense as they probably don't want to work forever, also employing someone and the associated costs, time and effort, as well as doing the administrative side of the business means you would likely be getting little reward for all of your time and effort.

      • cuteseal on 03/11/2018 - 10:36

        Understand your motivations OP, sounds good.
        I was thinking you could get a part time bookkeeper too or someone that can handle the backend stuff to make things easier. I did the books last time and it sucked big time :)

        • brownbag on 07/11/2018 - 11:39

          Thanks. I'm pretty good with bookkeeping and do it quite easily. I may do it for my wife (on my long train trip train home).

  • hawkeye on 01/11/2018 - 15:53

    Any accountant will tell you if you have the money pay cash. 5 year loan @ 5% will cost 2K ++ in the first year a small income @ 20% PAYG is only $400 ++ offset in tax break.
    Depends on how much you value an extra %1600 PA I guess.

    But then saying that 40K in the bank @ 4% is $1600 PA interest + your marginal tax rate is what you won't be getting.
    That would reduce your taxable income and stimulate hers at a lower rate so in that respect you'd be better off paying cash. Paying less tax always looks attractive.

    • serpserpserp on 02/11/2018 - 20:10

      What bank pays 4% interest on 40k? I want in on that TD.

  • Godric on 01/11/2018 - 16:07
    +1

    I don't know

  • holdenmg on 01/11/2018 - 16:30

    FF*, OPM. Other People's Money (1991)
    https://www.imdb.com/title/tt0102609/

  • Typical16-bitEnjoyer on 01/11/2018 - 18:54

    Nobody can answer this question unless you disclose the expenses.

    Rent? Outgoings?

    This will play a major factor.

  • echelon6 on 01/11/2018 - 19:04

    biz loan will be at commercial rates

    but loan financing is good cos deductible interest

    what to do what to do…

    you should redraw the money from your home loan to buy the biz - that way you enjoy deductibility (redraw counts as new loan and loan purpose is for buying the biz) and also low resi mortgage rates of circa 4%

    • brownbag on 02/11/2018 - 07:04

      good idea echelon6

    • serpserpserp on 02/11/2018 - 20:13

      You need to check the costs associated with doing this with the bank and if your loan product will allow you to do this.

      I think what you'll find is that you'll be able to redraw the 40k, but won't enjoy the deductibility.

  • MrBear on 02/11/2018 - 10:18
    +1

    lend the money.

    I think you mean "borrow the money".

    • brownbag on 02/11/2018 - 10:23

      yes, correct, I did mean to say that.

  • suntap on 02/11/2018 - 12:13
    +4

    I own a couple of businesses and have paid cash in full for some and "borrowed" money from myself for the others. I prefer going the route of a "loan" from myself to the business - more tax advantageous for myself (everyone's situation is different so you need expert advice on this.) What is more important than the funding, is the actual structure of the business ie. sole trader, partnership, trust, company etc.
    To loan the funds to my business, a pty ltd company, I utilise what is called a Div7a loan agreement, a legal document stipulating interest etc. between the business and myself. they are usually used when you borrow from the business but can go the other way as well. I did the loan as a shareholders agreement and I am the sole shareholder of the business. Lots for you to think about.

  • HeWhoKnows on 02/11/2018 - 16:25
    +2

    Is OP lending money or borrowing money????

    How can anyone run a business if they dont even know this basic difference?

  • HeWhoKnows on 02/11/2018 - 16:27

    But to answer OPs question its very important to have plenty of cash in the bank when running a business.
    Businesses go bust not from not making a profit but rather from not managing cashflow properly.

  • No ONE on 02/11/2018 - 17:59

    In pure cash terms, we’re better off by $450 -$500 a year buying the business in cash

    How did you come up with the figure. IMO, for a business $500 a year is very insignificant, so go for a loan.

  • raymosaurus on 02/11/2018 - 23:56

    Cash is folding money. I think you are asking about loan vs buying it outright, not specifically cash payment.

    It's 2018 but cash is still cash and not EFT payments.

  • Zonty on 03/11/2018 - 01:05

    I would say cash if that cash sitting in saving ac. The reason is if u put saving ac will make interest 2% which equal $800.00 (without tax) of$40000.00 and pay tax on it .

    Other side, if you take loan it will cost 5% min loan interest which will be $2000 interest cost per year. Let assume u not making money so interest will be exp which will help to recover 30% of business tax of profit .means $600.00, so actual you will pay is still 1400.00 which still higher cost then sitting in saving ac.

    Otherside if you have loan you can always use redraw to buy some personal item at cheap interest rate.so you have biggger cash flow in case you want expand business or buy car at cheap finance.

  • No ONE on 03/11/2018 - 10:59

    What is your business structure? Sole trader, partnership, company?

    If sole trader or partnership, it is better off to go cash to limit your liability in case business go bust.

    If it is a company then, loan would NOT be a bad thing; or you could use your own money to provide loan to your business (company) at the market rate. Interest would also be tax deductible. If this is a case, speak with a accountant.

    • brownbag on 07/11/2018 - 11:40

      sole trader, so I suspect you're going for cash. Cheers.

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