Acquisition loans are used to buy a business or its assets. When you are ready to take the next step and purchase your own business, a lot of information needs consideration. One important decision will be what kind of financing option works best.
INTRODUCTION
Buying a business in Canada can be both exciting, complex and challenging. The ability to buy an existing company and capitalize on business growth opportunities is the entrepreneurial dream. Entrepreneurs realize that a successful business purchase is a cost-effective way to increase sales and capacity, enter new domestic or international markets and grow a customer base.
Many business owners use the business acquisition strategy to buy a competitor or supplier/vendor. It's the ultimate way to fast-track business growth.
Empowering Entrepreneurs: Practical Financing Solutions for Business Acquisition in Canada
Finding the right financing mix/solution for acquiring a company can be challenging. The proper capital structure will help avoid potentially unforeseen challenges - When it comes to funding your transaction, successfully negotiating an optimal financing structure is key.
UNDERSTANDING ACQUISITION LOANS
The ability to succeed in acquisition loan financing helps borrowers acquire the business. It helps complete the total cost of the acquisition when combined with owners' own funds and other types of financing that might be needed.
Different factors play a crucial role in the types and terms of acquisition loans. Key issues are the size of the business, overall financial health and creditworthiness, borrowers' financial strength, and the ability to demonstrate a solid business plan strategy post acquiring the business. Naturally, the general health of the industry and economy can also play a crucial role.
WHAT ARE THE DIFFERENT TYPES OF ACQUISITION LOANS
Business acquisition loans can be grouped into different types of loans and financing :
Term Loans: These are straightforward loans with a fixed repayment schedule amortized over several years - A 5-year amortization is typical... A term loan be secured or unsecured, depending on the circumstances and type of lender and financing.
Seller Financing/ Vendor Financing: In some instances, the business's current owner will agree to provide financing to the buyer. This is often structured as a loan, with the business itself as collateral in a second position behind the senior lender on the transaction.
Asset-Based Loans: Asset-based lenders provide these loans and collateralize the business's asset, which is typically accounts receivable, inventory, real estate, and fixed assets. The loan amount typically depends on the appraised value of these assets.
Mezzanine Loans/ Cash flow loans: This type of loan combines debt and equity financing elements. It's typically used when a borrower can't secure enough traditional debt financing to complete an acquisition, and the focus on loan approval is strong cash flows, both historical, at present, and projected into the future.
Government Loans- The Canada Small Business Financing Program is a solid method of acquiring a smaller business, typically under 1 Million dollars in value - Financing a franchise is a popular use of the Government guaranteed business loan program. Variable rate loans are available under the program to purchase an existing business outright.
WHO ARE THE KEY PLAYERS / BUSINESS LENDERS IN CANADA
Numerous traditional and alternative financial institutions and commercial finance companies play a key role in business acquisition finance - These include:
Canadian Banks: These include Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, and Canadian Imperial Bank of Commerce, as well as Canadian Western Bank. They have extensive experience in business financing and offer a wide range of acquisition loan products.
Business Development Bank of Canada (BDC): The BDC is a government-owned crown corporation development bank that focuses on supporting the SME sector in Canada. It provides a range of business financing options.
Alternative Lenders / Asset-based lenders / Non-Bank commercial finance companies. Alternative lenders have emerged as KEY players in the business financing space. These firms typically offer more flexible lending criteria than traditional banks, which have more stringent credit criteria for approval.
Successful business acquisition finance is about understanding lenders' requirements and ensuring you meet qualifications. Let's investigate the steps required to achieve funding and ensure entrepreneurs/borrowers understand the application process.
ADVANTAGES OF BUSINESS ACQUISITION LOANS
Acquisition loans can be a great way to acquire your company's business and/or new assets. They allow you flexibility and ability when necessary based on individual circumstances or need-based business situations, not only to access the financing that offers secured/unsecured lending but also financing with more favourable terms and conditions than that of the startup phase/startup route option.
UNDERSTANDING QUALIFICATIONS AND WHAT LENDERS ARE LOOKING FOR
The process for getting a loan to buy a business differs from applying for other types of loans; lenders evaluate both your qualifications as a purchaser and, of course, the fundamentals of the business you are buying via the company's business credit score.
A lender will spend significant time evaluating business experience and the details of the business that you intend to buy to assess whether funding can be successful.
PERSONAL QUALIFICATIONS
Lenders will weigh your personal finances / personal credit score / personal net worth, and appropriate experience when considering a loan for business acquisition. Traditional financing institutions look for a bureau score in the 600+ range.
IT'S ALL ABOUT THE CASH FLOW AND DOWN PAYMENT!
Borrowers often use equity, in the form of cash contributions of equity financing, to reduce how much they must borrow when purchasing a company.
A positive cash flow and a substantial profit margin show that an existing business is doing well when looking at the target company's financials. Although traditional financing institutions such as banks will advise that a business may not be approved for a loan if it is operating at a loss or needs cash flow, alternative lenders have solutions that do not meet traditional financial metrics.
If a business has positive cash flow, the company is healthy and can support the debt required to facilitate your transaction.
An acquisition business loan to buy a business might require putting down 10%-30% of the value upfront as the owner equity component.
FINANCING THE BALANCE SHEET AND BUSINESS ASSETS
Business acquisition loans are possible if the business being purchased serves as collateral. Personal or business assets that may be included in the new company you're buying can act as collateral.
Having fixed assets on one's balance sheet can make a transaction easier to finance.
THE BUSINESS PLAN REQUIREMENT
Buyers will want to include a detailed business plan of the history and plans for your new company. A thorough business plan for your new business should consist of future financial projections that are conservative and realistic,
The projections provided should be backed up with data, which must be re-estimated for potential shortfalls. Projections for the future should be made based on previous data and backed up with verifiable information. 7 Park Avenue prepares detailed business plans for our clients that meet and exceed bank and commercial finance firm requirements and helps ensure a successful loan application
MANAGEMENT AND BUSINESS EXPERIENCE
If a business owner has little experience in their desired industry, that could be seen as a red flag to a bank or other commercial lender,
VALUING THE BUSINESS- BUSINESS VALUATION IS CRITICAL
Proper business valuation is key to determining the value you will put on the business purchase - The business valuation is key to the business lender and anyone else participating in financing the business purchase/business transfer.
Good business valuations reduce the risk for lenders and help with the likelihood of approval. Different types of valuations are used depending on various circumstances around the type and size of the business. These include market-based valuations, which consider competitors, and valuations that focus on the actual value of the business assets and any intellectual property. Income-based/cash flow-based valuation is also used in many circumstances.
When buying a company, knowing how much it is worth to ensure financing viability is essential. Purchasers want and need to know how much it's worth to buy a company! This is usually based on earnings before interest, taxes, depreciation, and amortization, often called "EBITDA."
Banks or lenders might ask for an independent business valuation on much larger transactions to determine if the value is accurate and fair. Being able to demonstrate what value you add to the business as a buyer that will make it better and more successful is essential to establish. You will likely need to provide bank statements, income statements, and tax returns to prove past revenue and profits for the business.
KEY INFORMATION REQUIREMENTS FOR YOUR APPLICATION
Purchasers should be able to provide current and historical financial statements of the business, your business plan, valuation information that is available or pertinent, a description of key assets/ collateral, and legal contracts or documents associated with the client base. It is critical to provide an executed offer-to-purchase agreement between the buyer/seller.
An overview of documents for buying an existing business might include the following:
Loan application
Personal federal income tax returns/business tax returns/business credit report
Financial statements of the target company
Agreement of purchase and sale
Schedules of assets such as fixed assets, accounts receivables, fixed assets/ accounts payable
Personal net worth / Good Personal credit history ( minimum credit score requirements regarding personal guarantee requirements / personal financial statement
A business plan which includes proper financial projections
BASIC FINANCING STRATEGIES
Financing an existing business with history, assets, cash flow, and an established team is generally considered easier than new start-ups. There are different types of business loans to finance acquisitions, including term loans, lines of credit, and in some cases, government-guaranteed loans.
Term Loans
Senior lenders are called the leading lender in an acquisition deal with seniority over other lenders participating in your transaction. Traditional term loans are the most common form of lending, with low-interest rates and long loan amortization terms. A conventional business term loan offers a fixed interest rate with predictable monthly payments. Senior lenders will usually have more restrictions than junior lenders.
Term loans are the most common for business acquisition since they fit well with the typical cost and long-term nature of purchasing an existing business.
However, bank lenders will have higher qualifications and standards for your business acquisition deal to fund a term loan.
Government Loan Programs
Small business loans are for purchasers contemplating smaller transactions for those who can't get traditional bank loans. A small business loan via the Canada Small Business Financing Program works with qualified borrowers who do not qualify for traditional bank loans. SBL loans are meant for smaller business acquisitions - These loans are available via a participating bank or credit union. Government loans also work well with startup businesses but not larger business purchases.
Borrowers should always consider key facts such as loan repayment terms, personal guarantees, restrictions on the use of funds, and criteria for loan approval.
Seller Note / Vendor Take-Back
Seller financing is a loan offered by the seller instead of a bank or other institution. Seller financing is an acquisition loan that provides the buyer with additional affordable and flexible financing. A business seller grants the buyer a loan as an alternative to getting additional financing required to close a transaction. It's a solid way to leverage existing resources in your transaction.
Mezzanine / Cash Flow Financing
Mezzanine financing is a higher-risk type of debt than senior debt, but it can be tailored to the business purchasers' needs. Mezzanine financing covers any shortfall between the purchase price and financing from other sources.
With this type of financing, companies can utilize their cash flow to service debt. It's based on how much your company will be able to produce in terms of profit and operating cash flows.
Equipment/ Asset Financing
Equipment financing allows more flexible requirements to get funds quicker than other options. Using equipment financing as part of a business acquisition loan can provide quick access to funding with fewer requirements than traditional loans. Post-acquisition buyers can also utilizesale-leaseback transactions to further monetize key assets or real estate with loan payments tailored to cash flow.
Business Credit Line -
You may need to bring additional money into the business via a business line of credit. When your company has a business line of credit, you can borrow up to a specific limit and pay interest only on the portion of the money that you borrowed. This is practical as it gives your business immediate access to funds up to a pre-established credit limit.
CONCLUSION - BUYING A BUSINESS IN CANADA
There are apparent solid advantages to purchasing an existing business - a product or service already in the marketplace and potentially positioned for business growth. A current workforce or management team and key supplies and vendors already in place are a tangible benefit.
Focus on the process and financing options you need to purchase a successful business with one or a combination of self-funding, seller finance, bank financing, leveraged buyouts, cash flow financing, and the alternative lending landscape. Due diligence is critical, and don't forget post financing needs to run and grow the business.
In navigating the path to a successful business purchase/business transfer, ensuring you are working with a trusted advisor who understands the financing landscape - Talk to the 7 Park Avenue Financial team about ensuring you have the right financial team in place,
Whatever the size and scope of your business, we can help you find a financing structure that ensures its success when you purchase a company with deal structuring suited to your transaction in the Canada business market. Is there a best acquisition loan to buy a business? Let the 7 Park Avenue Financial team ensure you have the financing you need for an acquisition loan to buy a business.
FAQ: FREQUENTLY ASKED QUESTIONS / MORE INFORMATION
What Type of Loans Are Used To Acquire A Business
Acquisition loans allow for business owners to obtain financing and purchase assets or companies using the collateral of those assets as assurance. Some typical loans to buy a business are traditional term loans, and Federal government-backed guaranteed small business loans, ad asset-backed loans from alternative lenders / ABL lenders.
What is a business acquisition loan?
A business acquisition loan is a type of financing used to fund the purchase of an existing business. It provides the capital for an individual or company to acquire another business outright or purchase a majority stake. The loan can cover the purchase price, working capital requirements, and other associated acquisition costs.
How do you finance a business acquisition?
There are several ways to finance a business acquisition:
Traditional bank loans via commercial banks or other financial institutions such as credit unions
Canada Small Business Financing Program - Government-guaranteed loans
Seller financing
Private Equity/ Venture capital
Crowdfunding/Peer-to-Peer lending / Friends and Family
How do I take over my business with no money?
Taking over a business with no money in Canada can be challenging, if not impossible - Some strategies to consider might include -
Seller Financing: Negotiate with the current owner to finance the acquisition by allowing you to make payments over time. This can involve a down payment upfront and installment payments over an agreed-upon period.
Partner with an Investor: Find a business partner or investor willing to provide the necessary capital in exchange for equity or a share of the profits.
Use Personal Savings or Assets: Utilize your savings or liquidate personal assets, such as stocks, real estate, or vehicles, to generate the funds needed for the acquisition.
Grants or Government Programs: Research grants, subsidies, or government programs available to support business acquisitions or entrepreneurship. These can provide financial assistance or access to low-interest loans. The Canada Small Business Financing Loan is similar to U.S. SBA loans. Most small business loans, such as SBL loans in Canada, cannot complete more significant transactions and are suited to small business owners.
Friends and Family: Seek financial assistance from friends or family members who may be willing to invest in your venture or provide a loan.
What is the line of credit for acquisition?
A line of credit for acquisition is a pre-approved borrowing limit extended by a financial institution to facilitate business acquisitions. It provides access to funds that can be used to purchase another business or finance growth opportunities. The line of credit allows the borrower to draw funds as needed up to the approved limit, and interest is typically charged only on the amount utilized. This form of financing provides flexibility and can be a valuable tool for businesses seeking to pursue acquisitions or capitalize on growth opportunities.
Asset-based lenders use the business's assets, such as inventories, fixed assets, receivables, etc, to secure financing.
What are things to consider when buying a business?
Factors to consider when buying a business include-
Assumption of existing debt
Ensuring purchase financing is in place
Ability to self-fund owner equity and maintain a cash reserve
Providing a line of credit is in place to run and grow the business post-acquisition - Many companies choose invoice financing/ factoring to fund additional working capital needs to boost operating capital and cash flows
What are the key steps to take when buying a business
Steps to take when buying a business include-
Performing adequate due diligence on business financial health and valuation
Ensuring proper capital structure/deal structure that complements price and repayment terms
Proper legal documentation for financing a legal business purchase
What are the Pros and Cons of A Business Acquisition Loan?
Advantages of a business acquisition loan:
It can be used to finance portions of the business that are not secured by collateral.
A long-term solution that helps during the early years of the company when growth is planned
Quick turnaround time for a loan approval when appropriate financing is sourced
Disadvantages of a business acquisition loan:
Lenders rely more on cash flow. assets, and credit score, as well as collateral and personal guarantees
Interest rates can be high and affect profitability in certain types of financing
Some loans may have stipulations or restrictions around the use of funds, maintenance of balance sheet ratios, etc
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' Canadian Business Financing With The Intelligent Use Of Experience '
STAN PROKOP
7 Park Avenue Financial/Copyright/2024
Stan Prokop is the founder of 7 Park Avenue Financial and a recognized expert on Canadian Business Financing. Since 2004 Stan has helped hundreds of small, medium and large organizations achieve the financing they need to survive and grow. He has decades of credit and lending experience working for firms such as Hewlett Packard / Cable & Wireless / Ashland Oil
