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COMPANY VALUATION METHODS FOR FINANCING A BUSINESS PURCHASE
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Financing & Cash flow are the biggest issues facing business today
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Successful mergers and acquisitions deal-making in Canada, particularly in the SME sector (small to medium enterprises) often starts with good business valuation.
It’s a bit of art and science quite frankly, and if you don't have an army of analysts of investment banking / private equity, or board of directors expertise for the valuation of mergers and acquisitions doing the work for you around discounted cash flow, etc these tips and advice should help in mergers acquisitions. Let's dig in.
HOW TO DETERMINE OF VALUE OF A COMPANY FOR ACQUISITION PURPOSES
The proper valuation methods of a business you are looking at buying or acquiring is often driven by the amount of capital you can either invest or raise financing for relative to the purchase price. While there are a number of ' rules of thumb' in business valuation nothing makes better sense than... you guessed it... common sense.
In hindsight buying a business or merging with one will seem like a good or bad deal. Many clients we meet boast they have been able to purchase a business for a great price when it comes to m&a valuation - with often the reason being poor sales and profitability that they hope of course to turn around.
THE IMPORTANCE OF ASSESSING CASH FLOW NEEDS
Knowing the amount of cash you need to both acquire and run the business is critical - and if you're not supplying equity then it's all about the right amount, and cost... of debt that you are willing to pay and take on.
A good business in Canada, when acquired, can often be financed with bank debt. However, our bankers and lenders need to clearly understand the nature of the business. Issues you will want to cover off are the seasonality of cash flows, client profiles, revenue recognition and billing issues and the level of financial control that you can demonstrate in running the business.
BUSINESS VALUATION APPROACHES
Cash flow analysis is critical, if only for the simple reason that your bank and other lenders want to know how and when they will be paid back. Here's where a clean business plan and cash flow forecast matter most. The latter document should show clearly how debt will be covered, and how profits will be generated via asset turnover, etc.
THE USE OF MEZZANINE CASH FLOW FINANCING TO FINANCE YOUR PURCHASE
If your transaction has a proposed high debt to equity ratio a non-bank lender will often be required to complete the deal. This type of deal can be successfully consummated via a cash flow mezzanine type loan or even a non-bank asset-based line of credit. This latter facility simply monetizes its assets to the maximum allows by your ABL asset-based lender.
THE PERSONAL GUARANTEE ISSUE
Very few deals in Canada when it comes to mergers and acquisitions can be accomplished without some level of personal guarantee from the purchasers. What many business owners don’t realize when it comes to the ' PG ' is that they are often negotiable in size, and can be negotiated to be released based on certain ' pivot points' in the future.
Although generally rare it is possible in Canada to have one bank place less emphasis on the personal guarantors than another bank. One age-old technique is to provide a resolution of your directors confirming personal guarantees of owners aren't allowed. That forces a bank to consider the transaction on its own merits. Possible, but not probable as we have hinted.
4 KEY ISSUES IN BUSINESS ACQUISITION FINANCE
At the end of the day it comes down really to 4 key issues you face when acquiring a business and financing the transaction:
1.The amount of internal capital you have and the external capital you need
2.Types of financing that will accommodate your transaction
3.Distinguishing between working capital needs and long term debt
4.Cash flow generation
We have seen there is no one single valuation of a company formula. Proper business valuation focuses on benchmarking the proposed deal within industry parameters, understand key operating ratios, and being able to put solid mgmt in place to close a deal and run a business.
CONCLUSION
For solid business valuation financing advice seek out and speak to a trusted, credible and experienced Canadian business financing advisor who can assist you with your financing needs when it comes to buying a business.
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Stan Prokop
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