Funding Goodwill: How Lenders Treat Goodwill When You Buy a Business

Goodwill is the part of a business's price that isn't backed by physical assets: its customers, brand, systems and earning power. Lenders can't sell goodwill the way they can sell property or equipment, so they lend against it cautiously, relying mainly on the business's historical earnings, the buyer's experience and extra security.

This post explains how lenders approach goodwill when you're buying a business, and what usually closes the gap. It builds on our acquisition finance guide and business acquisition finance checklist.

Why is goodwill hard to borrow against?

If the business fails, goodwill can fall sharply in value, so a lender can't count on recovering it. Physical assets such as property, equipment and stock have a resale value. Goodwill only has value while the business keeps trading profitably. That's why most lenders treat a goodwill-heavy purchase as a cash flow loan: they lend based on what the business earns, not on what they could sell.

What do lenders look at instead?

• Earnings history. Usually two to three years of financial statements, with normalisation adjustments explained.
• Debt serviceability. Whether earnings comfortably cover repayments on the acquisition debt and any existing debt.
• The buyer's experience. Industry experience and management track record reduce the lender's risk.
• Transferability. Whether customers, staff, supplier agreements, licences and leases transfer to the new owner.
• Key-person risk. How dependent the business is on the vendor personally.
• Additional security. Property or other assets the buyer can offer.

How is the funding gap usually closed?

Most goodwill-heavy purchases are funded with a mix of buyer equity, senior debt and sometimes vendor finance or an earn-out.

• Buyer equity. Cash contribution from the buyer. Lenders generally expect meaningful "skin in the game".
• Property security. Some buyers offer residential or commercial property as additional security. This can improve the terms, but puts that property at risk if the business can't repay.
• Vendor finance. The vendor defers part of the price. Lenders usually want this subordinated to their own debt. See vendor finance in acquisitions.
• Earn-outs. Part of the price depends on future performance, which can reduce the upfront funding needed.
• Specialist lenders. Some non-bank and private credit lenders take more goodwill risk, at a higher cost.

How can a buyer strengthen the application?

• Get clean, accountant-prepared financials and a clear explanation of any add-backs.
• Complete thorough due diligence, including customer concentration and contracts.
• Prepare a realistic forecast and a transition plan showing how you'll retain customers and staff.
• Agree a handover period with the vendor.
• Talk to a lender or broker before you sign, so the contract's finance clause matches a realistic timeline.

What about tax and structure?

How the purchase is structured (share sale or asset sale, which entity buys) affects tax, stamp duty and which assets the lender can take security over. Get advice from your accountant and lawyer on structure before you finalise the finance.

For more on how acquisitions are funded, see business acquisition finance.