There’s one way to buy a business that’s almost guaranteed to get the banks across the line.

Banks usually want property as security before they’ll lend money for the purchase of a small business, but many aspiring small business owners don’t want to put their house on the line.

It seems like an intractable problem but Campbell Flower of Odyssey Financial Management says one solution is to buy a business that has a property attached.

Banks will often accept this as security instead of the family home.

“Most people going into a new business or venture don’t like to use their personal house as security,” he says.

“If they’ve got no experience, they’ll need to put their house up. However, if they’re a business with a property attached . . . that means their house is freed up, so they don’t have to worry about it.”

Businesses with property attached often include motels and caravan parks, and small industrial businesses such as panel beaters or mechanics.

“I’ve sold quite a few coastal caravan parks and the like. It doesn’t matter which type of business it is, if there’s a property attached, the risk then becomes less because the bank can always draw down on the sale of the property to recover their funds if the business goes bad,” Flower says.

He says a tax-effective way to do this type of loan is for the SME’s self-managed super fund to buy the property with money borrowed from the bank.

The business earnings would then be used to pay rent to the super fund, which, in turn, would repay the bank.

It’s also a clever way of putting more money into the owner’s super fund.

Whether the borrower can put property up as security is just one of the factors that banks consider when they decide whether to lend money to buy a business.

David Bannatyne, general manager, small business at National Australia Bank, the country’s biggest business lender, says when deciding whether to lend to a potential small business owner, the bank consider “the three Cs”: their character, their capacity to repay the loan and their collateral.

“We do secure our larger loans against collateral, and, generally, that’s property,” Bannatyne says, referring to loans over $20,000.

Experience and expertise in the business sector that the borrower plans to enter is also important.

One of his clients has 20 years’ experience in the printing business. Based on that experience, NAB has lent the client more than $500,000.

“I’m lending to him because he knows the business and he has secured good contracts, but if someone just walked in off the street and said they wanted to borrow $600,000 to get into printing, we would be very reluctant to do that,” Bannantyne says.

“If a person understands the business and has been very successful at it, then we’ll fund them,” he says.

When banks assess the capacity to repay, they look at whether the numbers add up in terms of the business cash flow.

“That’s important, because I’ve had customers say to me in the past that the best thing we did was explaining to them that it wouldn’t work,” Bannantyne says. “When people are passionate about the business, sometimes the passions obscures their objectivity.”

Neil Slonim, whose business the BankDoctor advises small businesses on how to secure finance, says while banks tightened credit in the wake of the global financial crisis, they are keen to lend again but are more cautious.

“If small business owners can’t get money, it’s because they can’t demonstrate a plausible case to the bank for that money and it’s not the bank’s fault if they say they’re not going to give the money because the proposal doesn’t stack up,” Slonim says.

Using a business property as security for a loan means the borrower does not have to put their house on the line, but there are drawbacks.

Buying a business with a property attached increases the overall size of the loan, and, of course, that loan still needs to be serviced, Slonim says.

Borrowing against a house can mean a smaller loan that it is easier to repay.

“Most small businesses have a limited capacity to borrow and if you use that limited borrowing capacity to pay for property, then you’ve got less to use to pay for the business,” he says.

“The problem that a lot of people face when they buy a business is that they over-gear in the acquisition of the business and leave themselves short when funding the working capital of the business.”

Posted by Christopher Niesche – The Age on 29th June, 2015