YOU WANT TO FINANCE A BUSINESS ACQUISITION!
BUSINESS ACQUISITION FINANCING FOR AN EXISTING BUSINESS
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Financing & Cash flow are the biggest issues facing businesses today
ARE YOU UNAWARE OR DISSATISFIED WITH YOUR CURRENT BUSINESS FINANCING OPTIONS?
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METHODS OF FINANCING A BUSINESS PURCHASE IN CANADA
Financing Options for a business acquisition can be challenging, and here at 7 Park Avenue Financial, we're focused on providing you with solutions and information - let's dig in.
Acquiring a new business can be daunting, but it is essential for future success and the ability to grow the business to do your proper due diligence around buying a business and creating the optimal financing structure.
INTRODUCTION
Buying a business for growth and expansion? Securing finance for such transactions can be challenging, requiring thorough thought and strategic execution. Let the 7 Park Avenue Financial team demonstrate different funding strategies companies, and entrepreneurs can use for successful acquisitions.
Businesses are commonly funded by combining debt and equity. If the buyer's cash reserves aren't enough to finance the acquisition, they may consider external debt options, including bank loans, Government small business loans, private debt, or credit lines. Equity financing, which uses the buyer's own equity, is another potential funding strategy, but most business purchases require financing!
HOW DOES BUSINESS ACQUISITION FINANCING WORK?
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Company Funds: Utilizing the company's substantial cash reserves for a wholly cash-financed acquisition. It's a rare but total-control method, though hybrid deals are often preferred to manage risk and liquidity.
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Company Equity: A strategy where the acquiring company offers equity to the target company's owners. It allows for retention of control, creating a new entity or a separate structure under a holding company.
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Earnout: Also known as seller finance - where a portion of the acquisition cost is linked to the future performance of the acquired firm. This method benefits sellers through future revenues and helps buyers in risk mitigation.
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Leveraged Buyout (LBO): This strategy involves using the target company's assets as collateral for debt, with minimal upfront investment. Despite its high potential returns, it carries elevated risks around servicing debt.
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Business Acquisition Loan: A specific type of loan taken out via a traditional funder or non-bank asset-based lender to acquire another business or asset, typically featuring certain time limits and eligibility criteria.
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Bank Loan: A common choice, particularly for small to medium-sized enterprises, where acquired assets and cash flows are collateral to secure the loan.
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SBL Loan: Similar to the U.S. Small Business Administration (SBA) program, the Canada Small Business Loan Financing Program offers attractive acquisition terms, covering a large portion of the acquisition value with competitive interest rates and repayment periods. The loan cap on the program is 1.1 million dollars - Many franchise purchases are financed under the program. A minimum credit score of 650 is typically required by the lender
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Asset-Backed Loan: A loan based on the target company's asset value rather than its liabilities. It is a higher risk, as it depends on the liquidation value of the assets. Asset-based lenders can play a key role in financing business acquisitions.
UNDERSTANDING THE BUSINESS ACQUISITION PROCESS
A business acquisition, buying an already established business instead of starting a new one, is a key strategic choice for entrepreneurs aiming to penetrate new markets, grow their existing operations, or gain a competitive edge.
Understanding the crucial aspects of a business acquisition, such as due diligence, valuation, and negotiations, is essential before exploring financing options.
The advantage of acquiring an existing business is access to an established customer base, tested products or services, and a well-known brand. This decreases the risk of starting a new enterprise and could lead to faster returns on investment. Moreover, the acquisition can provide access to the existing management team's expertise and knowledge, offering a head start in managing the business successfully.
However, arranging finance for a business acquisition can be challenging and demands solid and careful planning, thorough research, and comprehension of the various financing alternatives.
It may seem like numerous finance options are available, but that will both depend on what stage of the business cycle the target company is in. Bottom line? The appropriate capital structure will position your business for more growth and help you make the transition smoother.
Companies and sole entrepreneurs use various methods to finance their acquisitions of an acquired business. One way is through direct acquisition financing, which provides funds for the purchase price or other related costs associated with an acquiring company's business transactions, such as fees -More commonly, there is more than one solution required to cobble together the appropriate finance package. The issue of debt and cash flow from operations is key given that acquisition loan payments must cover interest and financing costs to ensure a successful acquisition.
FINANCING ACQUISITIONS
When it comes time to acquire a company, you need a financing structure that will allow for an easy transition and position the company well in the years ahead. There are several types of acquisition funding:
Bank loan / Term Loans ( typically five years), Operating Line Of Credit / Revolving Facility, and potentially a seller financing contribution and owner equity financing.
Understanding how each type of loan works can be challenging, but finding the right one or combination is critical to business acquisition success.
ESTABLISHING THE RIGHT PURCHASE PRICE / BUSINESS VALUATION
When financing a company and assessing the need for a financing package, the first step is establishing its worth.
The value of any business usually comes from its profitability as measured by earnings before interest, taxes, depreciation and amortization (EBITDA). Additionally, the buyer should spend an appropriate amount of time to ' normalize ' the current financials to reflect post-acquisition operations, eliminating any non-recurring expenses under new ownership - this will help accurately reflect future cash flows and profits. Proper normalization of historical financials will help eliminate financing risk around the business's assets.
SENIOR LENDER CONSIDERATIONS IN YOUR TRANSACTION
In an acquisition deal, one senior lender typically provides a loan that is secured on assets like accounts receivable and inventory as well as the cash flows. This senior debt has priority over other more junior creditors and provides a claim on the assets to protect financing and repayment. Senior lenders are typically banks, nonbank commercial finance companies, asset-based lenders, and certain specialty finance firms.
A senior lender will have the most restrictive repayment terms and will often require a certain level of reporting, financial covenants, and the need to maintain certain financial ratios within the business financial statements.
Leveraged buyouts are financing in which the buyers use debt to purchase company assets. An adequately structured leveraged buy-out will is sometimes a higher risk strategy but eliminates the need for additional financing in some cases and can be a high-reward scenario when properly funded while allowing the company to repay the debt. With current interest rates at all-time low LBO and asset-based financing deals are popular.
GOVERNMENT LOANS - When it comes to buying a smaller business, there are many options available. One of the more straightforward methods is with an SBL loan that comes with attractive and competitive interest rates. When looking to purchase an existing business or land, there are many options that you may not have been aware of, including the federally guaranteed Canada Small Business Financing Program. Talk to the 7 Park Avenue Financial team on how this financing, structured as a term loan, can help you buy a business or franchise in Canada. It's a great and widely used program for small businesses in Canada - allowing banks and credit unions to fund acquisitions they might otherwise choose not to. Personal guarantees and personal capital requirements are also limited under the loan program.
ASSET-BASED LOANS - When acquiring a company with an asset-backed loan, you are using the value of the substantial assets and certain business fixed assets generated by your target firm to acquire the company.
Unlike in the case of leveraged buyouts, where financing is generally provided on the basis that acquisition will generate cash flow and therefore provide profit for those who financed it (i.e., banks), this type if transaction relies more heavily upon expectations about future sale or liquidation proceedings in the event of a default.
Abl lenders are great providers of acquisition loans and revolving lines of credit to support the business. ABL loans are effective balance sheet financing solutions.
CONSIDER VENDOR DEBT AS A PART OF YOUR TRANSACTION
A seller's earnout is a creative way to help finance an acquisition. Vendor takebacks or seller notes, where sellers agree to be paid portions of their settlement with interest over time, can cover a part of the debt you take on to buy a business.
In some cases, a vendor note is based on the performance of an individual company. This can be increased or decreased depending on how much cash flow is produced during repayment.
Vendor notes help to offset external debt and can be very creatively structured. They are helpful because they come with fewer restrictions and rank behind other external lenders - it's a patient form of financing that can even be helpful if the future business runs into challenges.
The other compelling reason is that oftentimes one or both parties want the vendor to stay involved in the business in some capacity to ensure a smooth transition.
CAN MEZZANINE FINANCING HELP YOUR TRANSACTION CLOSE SUCCESSFULLY?!
Mezzanine financing, also called unsecured loan cash flow financing, is often used to cover any gap left between the purchase price and other funding sources. It has a higher interest rate than senior debt but more flexible terms.
COMMON MISTAKES TO AVOID WHEN PURCHASING A BUSINESS AND FINANCING THE ACQUISITION
Based on our experience here at 7 Park Avenue Financial here are some common mistakes to avoid when financing a business acquisition:
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Neglecting Comprehensive Due Diligence: It's vital to conduct extensive due diligence, which involves examining the business's financial statements, federal income tax returns, contracts, and legal obligations. Skipping this can lead to unanticipated financial consequences.
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Underestimating Costs: Remember that acquisition involves more than the purchase price, including legal fees, accounting costs, valuation expenses, and working capital needs. Overlooking these can cause cash flow issues.
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Lacking a Contingency Plan: A backup plan is essential if financing fails or unexpected problems arise during the acquisition. This could include looking at other financing methods, bringing in more investors, or renegotiating the acquisition terms.
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Overlooking Personal Creditworthiness: Lenders consider your credit score. Maintaining a good credit score, clearing debts, and addressing credit report discrepancies are important; ignoring these can hinder your financing prospects.
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Poor Communication and Negotiation: Effective communication and negotiation are vital to securing financing. Communicate your requirements, objectives, and financial forecasts to lenders, and be ready to negotiate financing terms.
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Hastening the Process: Securing acquisition financing requires careful planning and time. Speeding the process or making quick decisions can lead to costly errors or unfavourable terms. It's crucial to research thoroughly, prepare the necessary documentation, and negotiate the best terms before proceeding.
KEY TAKEAWAYS
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Traditional bank loans for business acquisitions
- Widely used method for financing acquisitions.
- Banks offer term loans, lines of credit, and equipment financing.
- Requires solid business plan, financial projections, and strong credit profile.
- Challenges: may be difficult for first-time entrepreneurs or those with limited collateral.
- Banks require a down payment, typically 10-30% of the purchase price.
- Additional risk: banks may require personal guarantees.
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Government Small Business loans for business acquisitions
- Alternative for those who may not qualify for traditional bank loans.
- Loans partially guaranteed by the government, reducing risk for lenders.
- Many small businesses, including franchises utilize this program
- Offers longer repayment terms and lower down payments than traditional bank loans.
- Drawbacks: time-consuming application process and extensive documentation requirements.
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Alternative financing options for business acquisitions
- More flexibility, suitable for unique circumstances or specific financing needs.
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Asset-based lending
- Asset-backed financing is provided based on the value of the acquired assets, such as accounts receivable, inventory, equipment, or commercial real estate owned by the business.
- Secured by the assets, reducing lender's risk and potentially offering more favourable loan terms.
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Seller financing
- The business seller provides a portion of the funding.
- It offers flexibility in terms and can facilitate a smoother transition of ownership.
- It may not suit all business acquisitions, as terms and interest rates vary.
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CONCLUSION
Acquiring another business is a significant step towards growth and success. However, selecting the right financing method is crucial for a successful acquisition. Each deal is unique, and businesses must carefully evaluate their financial position and goals to choose the most suitable financing approach. Companies can secure financing that aligns with their growth strategies by considering the long-term costs of running the acquired business.
Properly structured acquisition financing helps fund mergers and acquisitions. Leveraging existing assets and cash flows provides access to capital.
The right business acquisition finance depends on your company's needs, the type of industry, and what stage of the life cycle a company is in. Businesses come in all shapes and sizes, so you should talk to 7 Park Avenue Financial about flexible financing options that fit your needs.
There can be a lot of different financing options for your company, depending on the goals and needs.
However, you must consider an acquisition's implications before moving forward with any deals- speak to 7 Park Avenue Financial, a trusted, credible, and experienced Canadian business financing advisor who can ensure your acquisition funding needs are met.
We will work closely with you in the most efficient way and timely way possible.
FAQ: FREQUENTLY ASKED QUESTIONS / MORE INFORMATION
What are the financing options to acquire a business? How does acquisition financing work?
Lender financing can come from self-funding/ down payment, seller finance/vendor takeback, and bank or commercial finance company or asset-based lending that will allow a company or sole buyer to acquire a business. Various subsets of acquisition financing might include ABL, Mezzanine Financing, Leveraged buyouts, etc. More significant transactions may sometimes be facilitated by a private equity firm, "family offices" or various online lenders.
In the U.S., Small business administration loans are used to fund many business purchases - the Canadian equivalent is the Industry Canada small business financing program which provides guarantees and safety measures to participating financial institutions.
What is the best way to finance a business acquisition?
The ideal method to finance an acquisition depends on factors like the acquiring company's financial position, the acquisition's size, and risk tolerance. A balanced approach involving debt and equity financing is often practical, leveraging existing resources and preserving liquidity. Creative options like earnouts or joint ventures can offer added flexibility and benefits for buyers and sellers.
How can a company finance an acquisition?
Companies have several methods to finance an acquisition:
a. Debt Financing: Using external sources like bank loans or lines of credit.
b. Equity Financing: Utilizing the acquiring company's equity by issuing stocks or offering equity to the target firm's owners.
c. Business Acquisition Loan: A specialized loan for acquiring another business or asset.
d. SBL Government Loan: A federally guaranteed loan for business acquisitions.
e. Asset-Backed Loan: Obtaining financing based on the value of the target firm's assets, using them as collateral.
What is the cheapest way to finance an acquisition?
The most cost-effective means of financing an acquisition is often using the company's or buyers' funds or equity. Larger business purchases would use partners such as venture capital firms or private equity firms. This approach eliminates interest expenses linked to external debt.
Moreover, if the target firm's owners accept equity as part of the deal, it reduces the requirement for significant cash payments. Employing innovative financing methods such as earnouts or joint ventures can also offer cost-effective solutions by tying payments to the acquired firm's future performance.
Where Can A Buyer Find a Business to Buy?
In Canada, commercial agents and brokers typically advertise the sale of companies through print and electronic media. However, individuals can also utilize their personal or business network to discover new investment opportunities. Many business owners prefer acquiring existing companies, which are often franchised or independently operated.
What is Vendor financing?
Vendor financing, also known as seller financing or owner financing, is a method of financing a business purchase in which the seller provides financial assistance to the buyer. In this arrangement, instead of the buyer obtaining the entire purchase price from traditional sources like banks or investors, the seller agrees to receive payment over time from the buyer.
The process typically involves the following steps:
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Business Purchase Agreement: The buyer and seller negotiate the terms of the business purchase, including the purchase price, payment schedule, and other relevant details. The agreement outlines the terms of the vendor financing arrangement.
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Down Payment: The buyer usually makes a down payment upfront to the seller. This down payment is a portion of the total purchase price and is paid when closing the deal.
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Installment Payments: After the down payment, the remaining balance is paid to the seller in installments over a specified period, typically through regular monthly payments. The payment schedule and interest rates, if any, are outlined in the purchase agreement.
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Security Agreement: A security agreement may be created to secure the seller's interest in the business and protect their investment. This agreement may include collateral, such as the purchased company's assets, which the seller can reclaim if the buyer defaults on payments.
Vendor financing can be beneficial for both buyers and sellers:
Benefits for Buyers:
- More accessible Financing: Buyers with limited access to traditional financing may find it easier to secure a business acquisition through vendor financing.
- Negotiable Terms: Buyers may have more flexibility in negotiating payment terms with the seller, such as interest rates and repayment duration.
- Reduced Upfront Costs: The down payment is typically lower than the total purchase price, which helps preserve the buyer's capital and reduces the personal guarantee and equity investment component of business financing
Benefits for Sellers:
- Attract More Buyers: Offering vendor financing can make the business more appealing to potential buyers, increasing the pool of potential purchasers.
- Steady Income: Sellers receive a steady stream of income from the installment payments, potentially yielding a higher return than other investment options.
- Faster Sale: By providing financing, the seller can expedite the sale process and complete the transaction more quickly.
It's essential for both parties to carefully evaluate and document the terms of the vendor financing arrangement in a legally binding agreement to protect their interests and ensure a smooth transaction.
What are the key steps to successfully finance a business purchase?
- Assess your financial readiness by evaluating your credit score, history, and assets.
- Prepare a comprehensive business plan that outlines your vision and financial projections.
- Research and compare financing options, considering pros and cons.
- Gather all required documentation for the chosen financing option.
- Submit your application with accurate and complete information.
- Negotiate financing terms to suit your needs.
What are some tips for negotiating financing terms?
Tips for Effective Negotiation of Financing Terms for Business Acquisition:
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Know your numbers: Understand financial projections, valuation, and ROI to support your negotiation arguments.
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Highlight your strengths: Emphasize experience, industry expertise, customer base, or unique advantages.
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Be prepared to compromise: Find a balance that benefits both parties for a successful deal.
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Seek professional advice: Consult with financial advisors such as 7 Park Avenue Financial, lawyers, or accountants experienced in acquisitions.
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Consider long-term implications: Evaluate cash flow, profitability, and growth potential under the negotiated terms. Choose options aligned with your business goals.
What are the Pros and Cons of Different Financing Options for Business Acquisitions:
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Traditional Bank Loans:
- Pros:
- Lower interest rates compared to alternative financing options.
- Established and reputable lenders.
- Potential for building a long-term relationship with the bank.
- Cons:
- Strict eligibility requirements.
- Lengthy application and approval process.
- Need for collateral and personal guarantees.
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SBL Loans:
- Pros:
- Government guarantee reduces the risk for lenders, similar to U.S. sba acquisition loans
- Longer repayment terms and lower down payments for business acquisition loans
- It can be suitable for entrepreneurs with limited collateral or credit history.
- Cons:
- Complex application process.
- Requires thorough documentation and financial statements.
- Longer processing times compared to traditional bank loans.
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Alternative Financing Options:
- Pros:
- More flexibility in terms and conditions.
- It can be suitable for unique circumstances or specific financing needs.
- Potential for quicker approval and funding.
- Cons:
- Higher interest rates compared to traditional bank loans.
- Limited availability and options.
- It may require additional collateral or personal guarantees.
Remember to carefully assess these factors and consider your business needs and circumstances before selecting the right financing option for your business acquisition.
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