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HOW TO BUY A BUSINESS IN CANADA

Buying a business is one of the most rewarding ways to grow a company as an entrepreneur. If you're ready, let's see what's involved in buying a business including how financing, valuation, continuity, etc.

Buying a private company from a business owner can be an intricate and complex process. Your successful business acquisition requires careful planning, as well as the right team on board regarding financing and other key advice.

When you consider buying an existing business, or even a management buyout there are many things to take into consideration. One important factor is the financial health of the businesses and their chances of future success. Let's dig in on helping you as a business buyer make better-informed decisions.

THE SELLER PERSPECTIVE

The motivation for a business sale often arises from the owner/vendor looking to retire and wanting to leave their business in capable hands. They will often consider funding part of the purchase so good long-term incentive structures are in place for all parties.

In the case of management buyouts, sellers look to retirement age and want to provide current team members opportunities opportunity while maintaining the legacy of the business. Keeping the buyer motivated to focus on future growth becomes an incentive for all.

UNDERSTANDING SELLER AND LENDER PARTICIPATION AND MOTIVATIONS

Seller motivations in a buyout can also be complex, but always comes back to ' Value '

Owners want fair compensation for their hard work over the years as well- helping build up company value - buyers at the same time want to ensure that any purchase price paid will generate future returns on capital via growth opportunities or cost savings.

Let's not forget that lenders also have a major interest here to ensure adequate returns on their loans.

WHY CONSIDER BUYING A BUSINESS

When an owner has a successful company but doesn't have a succession plan in place, they can consider selling to someone who does.

UNDERSTANDING THE SELLER

Seller /vendor motivations will vary based on the nature of the deal, in certain cases when management is buying the business owners want to compensate existing management for their work while at the same time crystallizing their investment.

Sellers also want to keep a certain level of confidentiality around the sale of the business - especially if there are sensitive aspects to the business. In many cases, sellers don't want to sell to existing competitors. They are looking for sophisticated buyers who will understand the operations of the business, especially if they have chosen to leave the business entirely.

VALUATION - WHAT IS THE BUSINESS WORTH

No buyer wants to overpay. It increases the risk of your investment. The ability to manage and assess growth and profits is key to business success . It's important to avoid valuations based solely on growth results while failing in operational success.

Sellers want fair compensation for their work in building the company so valuation is key to entering into business sale negotiations.

THREE METHODS TO VALUE THE BUSINESS

When a prospective buyer wants to place a value on the business various methods of analysis are available to the buyer - Three most commonly methods to establish a fair price are :

1. Market-based industry multiples around key elements around sales, profits, cash flow

WHAT MAKES A BUSINESS PURCHASE SUCCESSFUL

From a management, perspective owners should be focused on the ability and experience of future management. The ability to grow a business is key so the amount of cash flow, as well as current debt levels, is key to moving forward. A solid realistic valuation, as we have noted is critical, as well as ensuring a proper financing structure is in place on a go-forward basis. For an excellent article from FORBES on avoiding mistakes in a business purchase click here.

WHY IS THE RIGHT FINANCING FOR A BUSINESS PURCHASE CRITICAL

Purchasers of a business want to guarantee that the business can sustain itself with profits and the appropriate method of external financing. The ability of a business to have access to day-to-day capital from business lines of credit is key, as well as access to financing for new or upgraded assets via such facilities as lease finance.

Day-to-day cash on hand to address business needs for ongoing operations is key, thereby minimizing risk and ensuring a successful operation.

THREE CRITICAL CONDITIONS FOR FINANCING YOUR BUSINESS

When assessing your business purchase we can break down the final purchase decision into 3 critical areas :

The final price a buyer determines is as much an art as a science and subject to interpretation. Knowing the maximum you will be prepared to pay and finance is key, as is the comfort level a buyer has around the method of valuation chosen.

Your final capital structure for a completed purchase will be a combination of debt and equity - along with a cobbling together of other potential financings that might include mezzanine finance and seller note/vendor takebacks. Buyers will always tend to focus on the lowest cost of capital which typically will be from the senior lender on a transaction - Financing must be structured so as to successfully acquire the business as well as to allow for future growth.

Senior debt in the form of a term loan is most commonly the larger and least expensive source of funds - this acquisition term loan will typically be from a bank, a commercial financing company, or an asset-based lender.

In some cases, equipment leases for various types of assets might be in place, as well as working capital lines of credit that might be short-term in nature. Senior lenders will have first position security on all or most of the assets of a business - allowing them to take control of assets if necessary. These senior loans will also come with covenants and required balance sheet ratios, as well as the need for personal guarantees of owners.

THE IMPORTANCE OF DUE DILIGENCE - WHAT TO LOOK FOR IN FINANCIAL STATEMENTS WHEN BUYING A PROSPECTIVE BUSINESS

It's all about ensuring there are no surprises when business lenders request certain documentation to ensure deal underwriting goes smoothly. Be well prepared for financing to ensure you can minimize and address all issues that come out of the information provided by the seller. Last-minute surprises are never good in business purchase financing.

Spend a significant amount of time on the company's financials, including a review
of historic performance and :

Seller projections for future growth rates will provide you with help to make a final decision easier around the profit potential of the business.

FINANCING THE BEST STRUCTURE FOR YOUR PURCHASE OF THE BUSINESS

The total finance required for a buy‑out will depend on the purchase price, financing costs and any funding needed to meet capital expenditure or working capital balance needs for meeting accounts payable, funding advertising costs, etc.

Some buyers will find the need to take on existing bank debt in a combination of new external debt and any potential vendor take back

The business model must have the financial capability to service cash flow needs from any buyout financing from its operations.

THE VENDOR TAKE-BACK / SELLER FINANCE DISCUSSION

The vendor takeback is a solid method for buyers to consider to finance their purchase. Payments and interest rates are typically very attractive to buyers and tailored to the specific needs of the business. This type of financing also minimized bank and other external debt the buyer may need to take on - In general lenders favour seller participation in a business purchase or management buyout.

TYPES OF FINANCING

Ultimately a business buyout/purchase will be a combination of debt, owner equity and down payment as well as other sources of debt such as business credit lines and working capital financing, seller finance and cash flow loans under the mezzanine finance umbrella. Purchasers will have a goal of pursuing the lowest overall cost of capital - given that debt is cheaper than equity. A buyer's goal should be the focus on reasonable leverage around the final transaction.

Key Point - Most business acquisitions should include a proper business plan. 7 Park Avenue Financial prepares business plans for clients that meet and exceed bank and other commercial lender requirements.

MEZZANINE DEBT / CASH FLOW LOANS

Cash flow loans will in many cases be needed to bridge the gap between debt and equity and required financing. Mezzanine debt will in many cases come with higher borrower rates given its unsecured nature.

BUYER EQUITY / DOWN PAYMENT

The minimum down payment varies depending on the purchase price of a business, but in general it should cover 15-20% of your offer.

A business buyer's down payment/owner equity contribution is key to any successful purchase - Buyers will often be asked to contribute anywhere from that 15-30% of the purchase price as part of the optimal capital structure required in a deal

UNDERSTANDING THE CASH FLOW OF THE BUSINESS

Cash flow is the most important factor of most business purchases and it is of
crucial importance to your buyout analysis. Projection of cash flow statements around issues such as profits, necessary capital expenditures, and profits is key. It is often the key driver of a business valuation.

Cash flow is king is sometimes a mis-used business saying, but nevertheless key in buying a business in Canada.

PLAN FOR CHANGES IN CASH FLOW!

Cash flows will fluctuate in any business - Certain industries may n fact have certain typical perios where cash outflows exceed cash inflows. Plan for these fluctuations by ensuring adequate business lines of credit are in place. Proper cash flow projections will help ensure the actual timing of those ' short of cash ' periods in any company's business.

In some cases, business credit lines will need to be secured, and they might also be accessed via banks as well as ' ABL ' lenders. (Asset-based lenders)

TAKING ON THE RIGHT AMOUNT OF DEBT

Senior debt will most often come in the form of a term loan with set payment schedules around the acquisition - Flexible terms focus on key factors such as owner equity contribution, collateral and cash flow of the business, as well as potential business future performance.

Business buyers should focus on a required level of debt that is sustainable as the business operations and grows. Again, knowledge of cash inflows is key - lenders will focus closely on asset coverage and interest coverage to cover their debt support for the business. Long-term debt typically is 5 years in length, and may in many cases have the option to be renewed.

Financial covenants and balance sheet ratios the company is being asked to maintain

CONCLUSION - FINANCING THE RIGHT BUSINESS PURCHASE

FAQ: FREQUENTLY ASKED QUESTIONS / PEOPLE ALSO ASK / MORE INFORMATION

What steps to take when buying an existing business?

In considering a business purchase consider these required/recommended steps

1. Due diligence and market research

2. Focus on an optimal financing structure for the business acquisition

3. Decide on an asset sale or a share sale structure

4. Negotiate appropriate terms in the purchase and sale agreement

5. Use a lawyer for proper legal documentation of the business transfer of ownership

6. Engage appropriate experts such as bankers, lawyers, and a business financing advisor

Is it possible to buy an existing business?

How do you value a company?

What do lenders want to know in a business purchase?

Buyers should be expected to answer key questions around a business purchase application such as

- What is the current financial health of the company around key areas such as sales revenues, profits, and operating cash flows

' Canadian Business Financing With The Intelligent Use Of Experience '

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

How To Buy A Company | 7 Park Avenue Financial