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How To Finance A Business Acquisition In Canada
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Business acquisition financing in Canada comes with several myths and when it comes to arranging finance and a business loan for buying a business there are some key basics every business owner/entrepreneur needs to know.
It's easy to get bogged down in the legal and accounting jargon sometimes so here at 7 Park Avenue Financial we strive to give you the layman's version - in plain English!
STARTING THE VALUATION PROCESS IN ACQUIRING A BUSINESS
Business value and how companies are valued are key in a successful business purchase and financing for a small business. The pro's talk about ' future cash flows ' and ' earning potential ' but the formulas and calculations around these can sometimes be a little overwhelming with respect to the right purchase price. For a starter, the purchase price part of buying a business is key and should always require some third-party input from a business pro. While future earnings are key there are a number of areas that require your focus - including ' what are the cash flows today '!
The valuation of the target company you are considering purchasing is critical as it determines the worth of the company. Acquisition financing lenders will also place the same key emphasis on business valuation when it comes to business acquisition loans. That valuation figure provides a strong basis for banks, commercial finance companies, or asset-based lenders to determine the level of risk in a transaction.
Depending on the type of business transfer purchase you are considering and what industry the company operates in there are several ways to address a realistic valuation of the business - In many cases a good comparison can be made by researching similar companies in the same industry, ie a market-based value of the business.
When it comes to asset-intensive businesses the true value of the assets of the business helps backstop the valuation - in some cases appraisals might benefit the buyer as well as the lender. As in all businesses ' cash flow is king; so a strong assessment of how the business generates cash will be key in any valuation decision - understanding historical cash flows, as well as realistic projections, will also help determine repayment of business acquisition loans.
VALUING HARD ASSETS VERSUS SOFT ASSETS OF THE BUSINESS
Assets are a key part of any business purchase. More and more businesses today have ' soft assets ' which often makes valuation even harder. These typically aren't treated the same as hard assets, which can be more precisely appraised and valued. The bottom line is that you have to look at each asset, soft or hard, in the context of what they do for the business.
LIQUIDATION VALUES AND CURRENT ASSETS ON THE BALANCE SHEET
We can't count the number of times new business financing clients have told us they feel they ' overpaid' for the company they now own and run.
It's clear to us they never looked at each asset under the telescope, or even more precisely, ' under the hammer '. That ' hammer' refers to the idea of liquidation of the auction value of what an asset might bring under auction. Inventories and accounts receivable are also key aspects that require significant due diligence. You need to know those ' liquid assets ' ( A/R + Inventory ) are moving cash through the business. This can often easily be measured by applying basic '' days sales outstanding and ' inventory turnover' ratios to your analysis.
Hard assets often naturally enhance the value and financeable possibility of the business. A winning combination is good assets and good cash flows from those assets.
FOCUS ON COMPLETE DISCLOSURE IN YOUR DUE DILIGENCE PROCESS
Proper disclosure from the seller is a final point to focus in on - Beware of sellers with dark sunglasses! That of course refers to sellers who choose to keep buyers in the dark, and a purchaser who does not prepared to do proper due diligence. Can a deal be done in the dark? Absolutely! Will it be a successful deal for both parties? Probably not.
There's an old saying that the best deal /negotiation is when both parties feel they didn’t get all they wanted, and there’s probably a lot of truth in that.
ACQUISITION LOAN REQUIREMENTS
Depending on the type of financing you require as well as what type of business lender / financial institution is involved in your transaction they are some typical very specific requirements around loan documents required - They include:
Business financial statements / personal financial statements and net worth of purchaser
Tax returns
Financial statement info around accounts receivable agings accounts payable aging
Business plan and cash flow projections
Sales forecast assumptions post-acquisition
Financing The Business Purchase
1.SBL Govt loans -
The Canada Small Business financing program is used by many entrepreneurs to finance a business purchase via long term loans on smaller transactions in Canada - It is a popular option for a number of reasons and allows the buyer to work with a large choice of lenders including banks and credit unions. Recent changes to the program have increased loan limits to 1.1 Million dollars, as well as the ability to include business credit lines and working capital as components in the purchases.
One key advantage of government loans is the ability for buyers to access a competitive interest rate for either fixed interest rates or variable rates based on formula over Canada's prime rate. Franchise financing is a popular use of the program.
Government financing is also available for startup loans.
2. Asset-based lending - Asset-based lending can provide the same level of financing for success in buying a business via a leveraged buyout solution - When cash flow resources are stretched asset-backed lending solutions provide liquidity and relieve some of the stress around working capital business needs and debt repayment. Asset finance solutions are usually custom structured to optimize the true value of business assets such as receivables, inventories, and fixed assets and/or real estate of the business - ABL lending for business purchases is typically known as ' covenant light ' and doesn't come with many of the restrictions placed by bank lenders.
3. Bank Loan/term loans -traditional term loans are a strong choice for non-SBA business acquisition loans. You can acquire a term loan from a large number of lenders online, including banks, credit unions and online lenders.
The term loan structure is a lump sum acquisition loan and repayments are in fixed installments for the duration of the loan - unlike revolving credit lines that fluctuate and are drawn down based on day-to-day needs. Term loans for buying a business will come with the best interest rates and good business scores as well as personal credit scores of the owner are a must.
Most term loans are secured by a general security agreement on all the assets of the business as well as personal guarantees of the owner - Financials of the business will have to demonstrate the ability to repay the loan - which in a business purchase typically is a 5-year term structure. Banks provide online banking and business cards with many of their financial products.
4.Bridge loans -
Bridge financing solutions provide short-term liquidity as a buyer searches for more permanent funding - The business continues on a day-to-day basis while the long-term financing search continues - Asset-based loan solutions are the most typical funding sources for overcoming short-term capital needs and challenges.
5. Cash flow loans / Mezzanine financing - secured/unsecured business acquisition loans
Cash flow financing solutions are a solid acquisition tool for firms that are less capital intensive or asset-based and in many cases where intangible assets are on the balance sheet to a larger degree - For this method of financing the firm must demonstrate profit and cash flow to service debt based on solid financials and an experienced management team.
6. Seller financing/vendor takeback / Management buyouts
A sometimes overlooked method to solving the final part of the finance puzzle is ' seller financing' allowing the current seller of the existing business to structure a partial ' take back ' of the transaction, allowing you to fund a portion of the transaction without assuming debt. Management buyouts and leveraged buyouts can also be effectively financed with combinations of traditional or alternative finance solutions.
THE INTEREST RATE CHALLENGE
The interest rate on business acquisitions will depend on the type of financing as well as the overall credit profile of the transaction, the financing structure used, as well as of course the dollar value of the purchase price. In some cases, real estate may be part of the transaction and that typically is handled separately, with a common practice of having the real estate into a separate legal entity which is done for a variety of reasons.
CHALLENGES IN ACQUISITION FINANCING
As with any business financing solution borrowers should be focused on any potential risk and downside issues in their transaction. As well as the general complexity around any business purchase around true value and operational risks buyers should be aware of the significant emphasis placed on cash flows by traditional and alternative business lenders. A combination of the equity financing component of the buyer as well as the cash flow of the business will be key focuses of any business lender. Traditional lenders such as banks or bdc acquisition financing will place a large emphasis on personal credit history.
Interest rates have the ability to make or break a transaction - so the business capital needed to acquire the business must come with a commensurate interest rate that makes sense regarding repayment and the ability of the business to grow and scale going forward. Because of the variety of business lenders that can facilitate acquisition loan rates will vary considerably.
Certain lenders may also place restrictions on future borrowing, as well as require specific balance sheet ratios and loan covenants to be in place - Some of those might impact future borrowing around asses or may in some cases restrict growth to a certain degree. Purchasing the shares of a business via a ' share sale ' also comes with a level of risk around future liabilities.
CONCLUSION - BUYOUT AND ACQUISITION FINANCE SOLUTIONS
It's no secret that there are numerous advantages to buying a business with a business acquisition loan - Many of the assets of the business such as commercial real estate ( if applicable), Inventories and fixed equipment can minimize overall business credit risk - In some cases, even intellectual property and goodwill can be part of the optimal financing structure of the business purchase.
Many Canadian business financing solutions can be used post-acquisition to fund day-to-day growth needs such as equipment financing/equipment leasing, and revolving lines of credit to fund day-to-day operations are available. Depending on the credit quality and size of a business purchase most loans can be achieved within a reasonable turnaround time.
Speak to 7 Park Avenue Financial, a trusted, credible and experienced Canadian business financing advisor with a track record of business finance success who can help you purchase of a business with solid business acquisition financing that meets your needs.
FAQ: FREQUENTLY ASKED QUESTIONS / PEOPLE ALSO ASK / MORE INFORMATION
What is acquisition financing?
Acquisition finance is the method that buyers use to acquire a business via share sales as well as the company's assets via an asset-based sale. Successful acquisitions can allow for organic growth and in many cases economies of scale can be achieved with new ownership and company funds under loan programs that make sense. A small business loan solution is available via government loans and loans are repaid from the future cash flow of the business. Financing acquisitions for a newly acquired business will require that debt service can be maintained for repayment of the business via internal financial resources.
What is the best way of financing the acquisition?
Acquisitions are funded via a down payment/equity injection of the buyer as well as some combination of business senior debt and business line of credit financing post-acquisition. The acquired business's assets can be leveraged to help fund the acquisition. The company will pay interest on the acquisition debt and must demonstrate reasonable cash flow generation / ongoing cash reserves to make acquisition financing work.
How do you finance a business purchase?
Business purchases can be financed via business loans from traditional or alternative lenders as well as government loans that are available.
How do you structure a business acquisition?
Business purchases are structured via share sales, asset sales, and in some cases the merger of two separate entities.
How do you do due diligence on an acquisition?
The due diligence process in a business acquisition should include an analysis of debt and company obligations surrounding leases, contracts, and outstanding lawsuits, as well as customer analysis.
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