A client came to me looking for $150,000 to help purchase a business. She was a middle-aged mother who wanted to help her young daughter get established in business. Their family had been involved in the powder-coating industry for many years, and they had an opportunity to purchase an existing business from an owner who was retiring.
This wasn’t a new business starting from scratch. It was an established and profitable operation with existing customers and contracts. The family knew the industry well and believed they could continue operating the business successfully.
The Financing Problem
Despite the strength of the business opportunity, obtaining financing proved difficult.
The mother earned a relatively modest income, while her daughter was young and had some previous credit issues. From a traditional lender’s perspective, this made the application difficult to qualify.
They initially tried to obtain a business loan but were unsuccessful.
They then explored using the equity in the mother’s home and approached other mortgage brokers about arranging a second mortgage. Unfortunately, they were still unable to obtain the financing they needed.
That was when they came to me.
The Home Had Equity — But It Was Still a Difficult Loan
The mother’s home was appraised at approximately $630,000, with an existing first mortgage of about $337,000.
They needed another $150,000 for the purchase and another $7,000 to cover most of the fees.
That would bring the total borrowing against the property to approximately $494,000, or just over 78% of the property’s appraised value.
That was important because private lenders pay close attention to the amount of equity remaining in the property. With the total financing approaching 80% of the property’s value, there were fewer lenders willing to consider the application.
After reviewing the complete situation, I was able to find a lender willing to provide the financing they needed through a second mortgage.
The Financing
The financing was arranged at:
- Loan amount: $157,000
- Interest rate: 11.75%
- Lender fee: $5,300
- Broker fee: $2,500
This was expensive financing, but the clients understood the cost and believed the opportunity to acquire an established and profitable business justified using the equity in the home.
Putting the Home at Risk
Using a home to finance a business should never be taken lightly. With a second mortgage, the home is directly pledged as security for the loan.
However, it is also important to understand that obtaining a business loan does not necessarily isolate your home from the risks of the business. Business lenders may require the owners to provide personal guarantees or other security. The exact exposure depends on how the business financing is structured.
When comparing business financing with a mortgage against your home, it is important to understand the obligations and risks associated with both options rather than just looking at the interest rate.
Having a Way Out
With private financing, it is important to consider not only how to get the money, but also how the loan will eventually be repaid.
In this case, the family was purchasing an existing business in an industry they already knew. The business had established operations and existing contracts, giving them a reasonable basis for believing that it could continue generating income.
Their plan was to operate the business profitably and use the resulting cash flow to eventually repay the private mortgage.
That is what happened.
The family continued to operate the company successfully and was able to pay off the loan within a few years.
The Right Financing for the Situation
A private mortgage at 11.75% was certainly not inexpensive. But the interest rate was only one part of the decision.
The financing allowed the family to purchase an established business that they otherwise may not have been able to acquire. They understood the costs and risks involved, had experience in the industry and had a plan for eventually repaying the loan.
Private financing is not appropriate for every business purchase. But when traditional financing isn’t available, sufficient home equity may provide another option worth considering.
Sometimes the solution to a business financing problem isn’t a business loan. It may be finding another appropriate source of capital.
