Financing a Business Purchase: Strategic Options | 7 Park Avenue Financial

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A LOOK AT BUSINESS VALUATION METHODS IN FINANCING BUSINESS PURCHASES

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Financing a Business Purchase: Why Buy a Business?     

 

 

Why would business owners/entrepreneurs take on more risk and gamble when buying a business?

 

 

Of course, many feel that a business acquisition eliminates the risk of financial loss, if only because they are buying an existing business.

 

Knowing how to finance that purchase, including the various financing options available to existing businesses, such as support from angel investors and the Business Development Bank of Canada (if you’re the buyer), or how to maximize the benefits of final valuation. We’ll look at some key issues from the buyer's and vendor's viewpoints.

 

  

 

 

BENEFITS OF BUYING AN EXISTING BUSINESS   

 

 

 

Buying an existing business can be a great way to start or expand your entrepreneurial journey. Here are some benefits of purchasing an existing business:

 

 

• Established Customer Base: One of the most significant advantages is that an existing business already has a customer base. You can start generating revenue from day one without building a clientele from scratch.

• Proven Business Model: An existing business has a proven business model, reducing the risk of starting a new business. You can leverage the existing processes and systems that have already been tested and refined.

• Trained Staff: An existing business often comes with trained staff that are familiar with the operations. This allows you to hit the ground running without investing time and money in training new employees.

• Existing Infrastructure: An existing business already has an established infrastructure, including equipment, leasehold improvements, and intellectual property. This can save you significant upfront costs and time.

• Faster Growth: Buying an existing business can help you grow more rapidly. You can build on the existing customer base and revenue streams to scale the business more quickly.

 

  

 

 

BUSINESS ACQUISITION PROCESS  

 

 

 

 

The business acquisition process can be complex and time-consuming. Here are the general steps involved in acquiring a business:

 

 

1. Identify Your Goals: Determine what you want to achieve through the acquisition, such as expanding your customer base or increasing revenue.

2. Research Potential Targets: Identify potential businesses that align with your goals and criteria. Look for companies with strong cash flow and growth potential.

3. Evaluate the Business: Conduct due diligence on the target business. This includes reviewing financial statements, lease agreements, and intellectual property to ensure the company is a sound investment.

4. Negotiate the Purchase Price: Negotiate the purchase price with the seller, considering the business’s value, cash flow, and growth potential.

5. Secure Financing: Obtain financing for the acquisition. This could be through a financial institution or alternative financing options. Ensure you have an optimal financing structure in place.

6. Close the Deal: Finalize the acquisition by signing the purchase agreement and transferring ownership. Ensure all legal and financial documentation is for a successful acquisition.

 

 

 

  

  

 

  

WHAT ARE THOSE ‘SOFT FACTORS’ THAT LENDERS WILL LOOK AT?   

 

 

 

 

If you're the buyer, some soft factors exist in purchasing and financing a company.

 

When evaluating a business acquisition loan application, lenders will consider hard and soft factors. Soft factors include:

 

 

• Management Team: The lender will evaluate the management team's experience and expertise. A strong team with a proven track record in managing cash flow and growing the business can significantly enhance your loan approval chances.

• Industry Trends: The lender will consider the trends and outlook for the business's industry. Favourable industry trends can make the company more attractive to lenders.

• Market Competition: The lender will evaluate the market competition level and the business’s ability to compete. A company with a strong competitive edge is more likely to secure financing.

• Business Plan: The lender will review the business plan to ensure it is comprehensive and achievable. A well-thought-out plan demonstrates your preparedness and commitment to the business acquisition.

• Credit History: The lender will evaluate the credit history of the business and its owners to determine their creditworthiness. A strong credit history can improve your chances of securing favorable financing terms.

 

 

Although lenders might not necessarily address these issues with you directly, we can assure you they are looking at things like your management and industry experience, external economic conditions within your industry, and the potential finaceablity of your sale at a price you and a seller have agreed on.

 

Additionally, credit approval is crucial, as it depends on your creditworthiness and may require meeting specific security requirements.

 

 

 

 

 DON'T FORGET TO ADDRESS THESE ISSUES IN VALUING A BUSINESS: CASH FLOW  

 

 

 

 

Other miscellaneous issues (they might not be that miscellaneous) include due diligence around premises and licensing issues, environmental concerns, etc. If real estate is part of your transaction, almost no traditional finance solutions can be applied if there are environmental /contamination issues.

 

 

   

THE VALUATION PROCESS - HOW ARE EXISTING BUSINESSES VALUED?    

 

 

 

 

 

 

What is a company's value? Intangible assets, such as leasehold improvements and equipment, are valuable in securing funding for business operations.

 

Naturally, the seller and buyer’s method of ‘ value ‘ the business affects the financing needed to consummate the deal.

 

That number can vary differently if you have chosen one business valuation alternative over another. On larger, more sophisticated transactions in corporate valuation outside the SME/SMB sector, a professional chartered business evaluator might assist you while employing a valuation method best suited to the industry and type of business in question.

 

 

   

   

  

HERE ARE SOME WAYS TO VALUE THE BUSINESS PURCHASE - METHODS OF BUSINESS VALUATION / WHAT IS THE PURCHASE PRICE OF A COMPANY    

 

 

 

 

These methodologies are a classic bit of art and science and may include:

 

 

Return on investment required by the owner

 

Cash flow analysis (these must be realistic): Here, you need to understand past and future working capital requirements—the discounted cash flow analysis in financial statements.

 

Book values of assets - In many cases, either the buyer or the seller will want to have these appraised.

 

Whether it be a bank, commercial, or alternative lender, any business lender will want to see some key documents about the purchase and sale. They include:

 

The actual sale agreement itself

 

Existing financing in place—e.g., bank security, leases, contracts, etc. Lenders typically verify these by checking government PPSA filings showing secured lenders and what collateral they claim. It’s a good idea to address the potential Liquidation value of key assets and make sure an appraisal is done if one is required to determine and assist in values around the final purchase price as part of the valuation process.  

 

 

Up-to-date financial statements/tax filings

 

If you are buying a franchise, you will need permission from the franchisor to assess the valuation of a company/existing franchise. Financial institutions, such as banks and credit unions, will thoroughly analyze these financial statements and your credit history to assess lending risks when you seek financing to buy and operate a business.

 

 

   

 

NORMALIZING THE FINANCIALS / ADJUSTMENTS TO THE FINANCIALS    

 

 

 

In many business purchases, a lot of adjustments happen after the sale.

 

They might include which party collects the outstanding receivables, who keeps cash on hand, the value of inventory on hand at closing, and final payments due to leases, utilities, etc.

 

  

  

 

FINANCING OPTIONS FOR BUSINESS ACQUISITION     

 

 

 

 

There are several financing options available for business acquisition, including:

 

 

• Bank Financing: Traditional bank financing is a standard option for business acquisition. Banks offer competitive interest rates and flexible repayment terms, making them a reliable choice for many buyers.

• Alternative Financing: Alternative financing options like private equity and venture capital can provide more flexible financing terms and higher loan amounts. These options are beneficial for businesses with high growth potential.

• Seller Financing: Seller financing, where the seller provides financing for the acquisition, can be a viable option for businesses with strong cash flow. This option often features lower interest rates and flexible repayment terms.

• Equity Financing: Equity financing, where investors provide capital in exchange for ownership, can be a good option for businesses with high growth potential. This option can help you raise significant capital without incurring debt.

• Equipment Financing: Equipment financing, where the lender provides financing for specific equipment or assets, can be a good option for businesses with significant equipment needs. This type of financing can help you acquire necessary assets without depleting your cash reserves.

 

   

 

 

COMMON MISTAKES TO AVOID    

 

 

 

 

When acquiring a business, there are several common mistakes to avoid, including:

 

• Underestimating the Purchase Price: Failing to estimate the purchase price can lead to financial difficulties accurately. Ensure you have a clear understanding of all costs involved in the acquisition.

• Overlooking Due Diligence: Failing to conduct thorough due diligence can lead to surprises and financial losses. Review all financial statements, contracts, and legal documents carefully.

• Ignoring Cash Flow: Failing to consider cash flow can lead to financial difficulties and even business failure. Ensure the business has a healthy cash flow and that you have a plan to manage it effectively.

• Not Having a Business Plan: Failing a comprehensive business plan can lead to poor decision-making and financial losses. A solid business plan is essential for guiding your actions and securing financing.

• Not Seeking Professional Advice: Failing to seek professional advice from lawyers, accountants, and other experts can lead to costly mistakes and financial losses. Experienced advisors can provide valuable insights and help you navigate the complexities of the acquisition process.

 

 

 

 Case Study: Benefits of Financing a Business Purchase 

 

 

When a Toronto entrepreneur identified a profitable manufacturing business for sale in Ontario, the $2.3 million asking price seemed beyond reach with his available capital of just $300,000. Through strategic financing consultation, he structured a comprehensive acquisition package combining $1.1 million in BDC financing, $575,000 in seller financing over five years, equipment financing of $325,000, and his personal investment.

 

The carefully structured deal preserved $125,000 for working capital, included a 6-month interest-only period on the primary loan to manage cash flow during transition, and featured performance-based adjustments on the seller financing portion.

 

 

 

 

   

CONCLUSION   

 

 

 

How do we value a company? We get that one a lot. Small business acquisitions are predicted to rise significantly -

 

Whether you're the buyer or seller of small businesses,  knowing how to sell or finance a business purchase is key - 

 

7 Park Avenue Financial is a trusted, credible, and experienced Canadian business financing advisor that can assist you with your business valuation methods and finance needs.

 

 

   

FAQ   

 

 

 

How do I determine how much financing I need to purchase a business?

Calculate the total purchase price, including closing costs (typically 3-5% of purchase price), working capital needs (3-6 months of operating expenses), and potential renovation/improvement costs. Subtract available cash to determine your financing requirement.

 

 

What types of loans are available specifically for business acquisitions in Canada?

Canadian entrepreneurs can access several specialized financing options, including BDC business acquisition loans, Canada Small Business Financing Program loans up to $1 million, traditional bank term loans, and specialized acquisition financing through credit unions focusing on local business development.

 

 

 

How important is my credit score when seeking business acquisition financing?

Your personal credit score significantly impacts financing approval, particularly for businesses without extensive operating history. Most Canadian lenders require minimum scores of 680-720 for optimal terms, though alternative financing may be available with scores above 600 with additional collateral or guarantees.

 

 

 

What documentation will lenders require for a business purchase loan?

Prepare comprehensive documentation including 3-5 years of business financial statements, tax returns, detailed business valuation, purchase agreement, your personal financial statements, business plan with cash flow projections, and collateral documentation for best financing outcomes.

 

 

 

Can I finance 100% of a business purchase?

Complete financing is rare but possible through combined funding sources. Most conventional lenders require 10-30% down payment, but seller financing, equipment financing, and government-backed programs can be structured to cover up to 90-95% of acquisition costs in optimal scenarios.

 

 

 

 

What advantages does seller financing offer compared to traditional loans?

• Typically requires less documentation than bank financing

• Often features lower interest rates than market alternatives

• Demonstrates seller confidence in business viability

• Can include flexible repayment terms during seasonal fluctuations

• Frequently requires smaller down payments than institutional financing

 

 

 

 

How does leveraging multiple financing sources strengthen your acquisition?

• Reduces dependency on any single funding source

• Creates natural checks and balances on business valuation

• Improves financing terms through competitive scenarios

• Provides backup options if primary financing falls through

• Allows strategic allocation of collateral across funding sources

 

 

 

What benefits come from working with specialized business acquisition lenders?

• Deeper understanding of business valuation methodologies

• Experience with industry-specific performance metrics

• More flexible debt service coverage requirements

• Established processes for expedited closings

• Greater comfort with goodwill and intangible asset financing

 

 

 

 

How can proper acquisition financing structure improve post-purchase business performance?

• Aligns debt service requirements with business cash flow patterns

• Creates financial discipline through reporting requirements

• Potentially includes advisory services from lenders

• Establishes clear performance benchmarks through covenants

• Provides a framework for future expansion financing

 

 

 

 

What's the typical timeline for securing business acquisition financing in Canada?

 

Standard bank financing typically requires 60-90 days from funding application, while specialized acquisition lenders may complete the process in 30-45 days. Government SBL and government-backed programs generally require 75-120 days. Maintaining complete documentation packages and responding promptly to information requests significantly accelerates timelines.

 

 

How does financing differ between asset purchases and share purchases?

Asset purchases generally receive preferential financing terms with lower down payment requirements and longer amortization periods due to tangible collateral. Share purchases often require an additional 5-15% down payment and involve more complex financing structures that may include seller participation, especially for businesses with significant goodwill value.

 

 

Will I need to guarantee a business acquisition loan personally?

Most Canadian business acquisition financing requires personal guarantees from owners with 20% or greater ownership stake, particularly for businesses with less than $10 million in annual revenue. Limited guarantees capping exposure at specific amounts may be negotiable with a strong business performance history and substantial tangible asset backing.

 

 

Can I use the business's assets as collateral instead of personal assets?

Business assets typically form the primary collateral for acquisition financing, with equipment, real estate, accounts receivable, and inventory providing varying collateral values. However, most Canadian lenders require supplemental personal assets for first-time business buyers or acquisitions with significant goodwill value until established performance under new ownership.

 

 

What financing options exist if the business I want to purchase has inconsistent financial performance?

• Alternative lenders specializing in turnaround situations

• Higher equity requirements (typically 30-50%)

• Seller financing with performance-based payments

• Earn-out structures tied to improvement benchmarks

• Funding mezzanine with equity components

• Short-term bridge financing while establishing track record

 

 

 

 

What role does business industry classification play in terms of acquisition financing?

Industry classification significantly impacts available financing options and terms, with stable sectors like healthcare, professional services, and essential retail receiving preferential treatment. Cyclical or high-risk industries typically face higher down payment requirements of 25-40%, shorter amortization periods, and more stringent cash flow coverage ratios of 1.5x or greater.

 

 

How can asset-based lending enhance your business purchase financing package?

• Unlocks capital from accounts receivable (typically 70-85% of eligible value)

• Provides financing against inventory (typically 50-65% of value)

• Creates flexible funding that grows with business expansion

• Reduces reliance on cash flow metrics during ownership transition

• Minimizes personal guarantee requirements with strong asset pools

• Accelerates closing timeframes through simplified underwriting

 

 

 

What financing structures best protect against business performance fluctuations after purchase?

 

Interest-only periods of 6-12 months provide critical cash flow breathing room during ownership transition. Step-up payment structures align increasing payments with projected performance improvements. Performance-based seller financing ties payment obligations to actual results rather than fixed schedules. Seasonal payment adjustments match debt service to business revenue cycles. Operating line of credit buffers provide cash flow protection during unexpected downturns.

 

  

Citations

1. Business Development Bank of Canada. (2023). "Business Acquisition Financing Guide." BDC Business Resources, pp. 15-27.

2. Canadian Federation of Independent Business. (2022). "Small Business Transition and Succession Planning." CFIB Research Reports, Vol. 8, Issue 3.

3. Deloitte Canada. (2023). "M&A Financing Trends in the Mid-Market Sector." Deloitte Financial Advisory Services, Annual Review 2023.

4. Barker, J., & Thompson, R. (2022). "Creative Financing Structures for Business Acquisitions." Journal of Small Business Finance, 14(2), pp. 112-135.

5. Statistics Canada. (2023). "Business Ownership Transitions in Canada: 2018-2023." Government of Canada Economic Reports, Cat. no. 11-626-X.

6. Royal Bank of Canada. (2023). "Business Acquisition Financing: A Comprehensive Guide for Canadian Entrepreneurs." RBC Business Banking Resources.

Main Website URLs for Publications

1. Business Development Bank of Canada: https://www.bdc.ca
2. Canadian Federation of Independent Business: https://www.cfib-fcei.ca
3. Deloitte Canada: https://www.deloitte.ca
4. Journal of Small Business Finance: https://www.sbfjournal.com
5. Statistics Canada: https://www.statcan.gc.ca
6. Royal Bank of Canada: https://www.rbc.com