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Demystifying Business Purchase Finance: Canadian Options - A to Z!

How to finance the purchase of an existing business

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THE BUSINESS ACQUISITION LOAN SOLUTION

Business owners and entrepreneurs should know there are many ways to finance an acquisition when it comes to a prospective business purchase. Still, not all options will work for every buyer.

Let's cover common and not-so-common methods to fund a business purchase via a business loan/debt financing and what they entail so you know which one might be right for your situation, given that financing an acquisition can be challenging without the right information or assistance.! Let's dig in!

INTRODUCTION

In today's competitive business landscape, acquiring an existing business is often a strategic move that can lead to growth and expansion.

While buying a business comes with many potential benefits, financing the purchase can be complex and challenging. Financing is critical to your transaction!

Let the 7 Park Avenue Financial team show you the standard and not-so-common methods of funding a business purchase through various channels such as business loans, debt financing, government loans, and even seller financing.

We'll explore the factors buyers must consider, including the amount of funding required, the difference in financing small versus large purchases, and the type of financing needed post-acquisition.

WHAT DOES THE BUYER OF A BUSINESS NEED TO KNOW?

How much funding do I need to buy this business?

Is there a difference in financing a small purchase or a larger one

What type of owner equity/down payment is required

Does the business need to have substantial assets

Can a purchase be completed with ' no money down ' ( Spoiler alert - it cant)

What type of financing do I need post-acquisition

When should I commence looking for financing, and what is a typical ' optimal financing structure.'

WHAT AMOUNT OF FUNDING IS REQUIRED TO BUY A BUSINESS?

When you buy an existing business, the funds for this acquisition come from your cash and personal equity contribution and any external financing used to access competitive interest rates. The appeal to buying an existing successful business is that it is typically significantly easier to buy a company rather than start one! However, the ability to buy a business on an all-cash basis based on personal financing is often limited, even in smaller transactions.

The right financing makes a business purchase more affordable. Business owners will also recognize that additional funding might be required and should be planned for to run and grow the business post-acquisition. The bottom line? Business buyers should focus on the right financing and ensure they will benefit from a return on their investment.

FINANCING YOUR BUSINESS ACQUISITION

Entrepreneurs have many financing options they can use to buy companies. The most common ones will include one or various debt/cash flow/asset monetization and equity components. Smaller private transactions don't consider IPO/Venture Capital firms, Private equity firms - it's as simple as that.

EXPLORING AND UNDERSTANDING SELLER FINANCING

With seller financing, you can purchase a business without having to come up with all the funding if a seller note is part of your negotiation. The seller provides an allotted loan amount that might have different amortizations and repayment options.

When a business is sold, the seller prefers to get paid immediately. But sellers also have different perspectives on how much money should be offered as an incentive for someone else’s purchase of their business. Some might want more while others less, depending on their preferences or financial situation regarding a seller loan/note. Often tax considerations will be a part of that decision.

Many sellers want full payment as soon as possible and don't usually offer financing assistance - However, on average most will often cooperate with finance between 5% - 20%. This amount varies substantially based on each transaction type -

Buyers should also be aware that :

Lenders view seller financing as positive

They will require that the seller subordinate to their security/loan

GOVERNMENT LOANS

Industry Canada, via the Canada Small Business Financing Program, offers government-backed loans, one of the best financing options for small business owners purchasing smaller businesses. The government-backed guarantees allow lenders such as Canadian banks and credit unions to provide capital with confidence that they will be compensated in case of a default.

The terms and rates on an SBL loan can sometimes even beat out traditional alternatives with competitive interest rates and monthly payments based on a term loan structure, so explore all your choices before applying and talk to our 7 Park Avenue Financial team about how this type of loan might make your purchase easier.

Government business loans can be an excellent option for financing small businesses under a purchase. The program provides lender guarantees and safety measures for acquisitions with firms of less than 10 Million dollars in revenue, along with those competitive rates and attractive financing terms under a standard term loan structure. Financing can also be augmented or sourced via the financial institution and Canada's crown corporation business development bank, a non-bricks and mortar organization throughout Canada.

Buyers contemplating government loan assistance should know there are some minimum qualification guidelines. Still, participating financing institutions, as lenders, have the freedom to add their criteria for a small business purchase.

Basic qualifications under the program are good credit scores, the ability to put down some owner equity and disclose personal financial resources, and ensuring you have solid business experience in the target industry, as demonstrated by a solid business plan.

BANK LOAN & NON-BANK COMMERCIAL FINANCE FIRMS

While conventional loans / unsecured loans might be more challenging to achieve than government financing assistance for the purchase price of existing businesses, they come with more stringent requirements that can challenge some business purchasers under a business credit score review.

Here, the focus is often on assets, personal collateral, excellent personal credit, and good business and management experience - A solid and realistic business plan should often accompany this type of financing request.

7 Park Avenue Financial prepares business plans for clients that meet and exceed bank and commercial lender requirements.

The most typical bank/finance firm loan for your acquisition will be a conventional term loan. Focus on ensuring you can meet the requirements of traditional financing institutions while limiting giving up personal assets for lender security. Also, goodwill and intangible assets are difficult to finance under most circumstances.

ASSUMING EXISTING DEBT

When purchasing a business, a prospective owner can finance part of the purchase by assuming some company's existing liabilities. These may include outstanding loans and trade payables, transfer of existing licenses, etc.

How these debts are considered depends on how much power sellers give up during their sale; Also, note that certain debt assumptions require lender approval, so ensure all parties agree before moving forward!

FRIENDS AND FAMILY? FAMILY OFFICES?

Finding the proverbial ' friend and family ' investor, or what is known as a family office, to participate in an acquisition is difficult.

Acquaintances and specialized networking events can be a source of information when you need to augment personal funds. Investors and family offices can be flexible, don't conform to conventional lending standards, and might consider equity financing. Third parties you don't know are also very selective in who they work with. They play a similar role as a private equity firm or venture capitalist would but for significant opportunities in acquisition financing.

YOUR DOWN PAYMENT / OWNER EQUITY

Equity injections are common in all business acquisitions when you are looking to obtain financing. The buyer must put down some cash as collateral, and it can't come from just the seller's resources.

Depending on your purchase's size and credit risk, anywhere from 10% to 40 percent is usually required as an equity injection. For government loans, a smaller equity injection demand is typically required.

Owner equity usually comes from personal finances such as savings accounts and retirement funds- though it's important to note that other cash in kind, such as our aforementioned seller financing, can be viewed as an additional financing source.

LEVERAGED BUYOUT /ASSET-BASED LENDING

Many buyers of a business looking to maximize their financing while limiting their equity injection overall often use the business's assets, like equipment or real estate, for other business collateral to complete an acquisition.

Leveraged assets in buyouts are becoming more common in Canada.

The structure can be simple at first glance; however, an intricately negotiated set of terms often makes it difficult without professional assistance from seasoned business financing advisors or a lawyer or accountant familiar with these types of transaction methods.

Many buyers assume that every leveraged buyout or asset-based lending solution requires no equity injection from the buyer. This assumption is incorrect. The misunderstanding is based on how transactions are described in popular business media.

Business purchasers like asset-based lending solutions and leveraged transactions as it helps limit new equity.

ASSESS THE NEED FOR FURTHER FINANCING POST-ACQUISITION WHEN BUYING AN EXISTING BUSINESS

When a company is purchased, it should be recognized that further funds will potentially be required to run and grow the business under the constraints of the current financial statements and financial performance of the existing company.

Most businesses will require additional funding to cover the initial operations on an ongoing basis for a new business purchase.

Cash flow problems often arise because clients / existing customers will pay their invoices in a less than timely fashion - Balance sheet funding solutions such as factoring, business line of credit, asset-based lines of credit, equipment financing, and sale-leasebacks all can provide additional capital for the business you are acquiring.

KEY TAKEAWAYS

Diverse Financing Options: From traditional bank loans and non-bank commercial finance firms to government-backed loans, numerous financing avenues are available for purchasing a business in Canada.
Seller Financing Insight: Learn how seller financing can be part of your negotiation and what terms and considerations are often associated with this creative method of funding the business purchase
Importance of Timing: Understanding when to start looking for financing and recognizing the optimal financing structure can make a difference in the transaction's success.
Understanding Equity and Down Payment Requirements: Knowing what's required and what can be leveraged is crucial from owner equity to down payment structures. Acceptable Debt-to-equity ratios are essential to lenders!
Government Loan Assistance: Know how Industry Canada's Canada Small Business Financing Program can provide competitive terms for small business acquisitions.
Leveraged Buyouts and Asset-Based Lending: Learn how assets like equipment or real estate can be used as collateral to maximize financing and limit equity injection.
Assessment of Post-Acquisition Financing Needs: Recognize that additional funds may be required for growth and smooth operation in areas such as business lines of credit to support sales growth.
Friends, Family, and Family Offices as Resources: Explore unconventional financing methods through acquaintances, specialized networking events, or family offices.
Professional Guidance is Key: Whether it's seasoned business financing advisors such as 7 Park Avenue Financial, or specialized lawyers, seeking professional assistance can simplify the process and help avoid common pitfalls.

CONCLUSION: BUSINESS ACQUISITION FINANCING

When buyers seek financing too late in their transaction, they are often left in the dark or behind. The best time to consider financing options is well before you are ready to submit an offer.

Make sure that your transaction is contingent on obtaining financing and ensuring you have adequate protection. Speak to 7 Park Avenue Financial, a trusted, credible, and experienced Canadian business financing advisor with acquisition financing experience to assist you with a smooth and successful business transfer.

FAQ: FREQUENTLY ASKED QUESTIONS / MORE INFORMATION

Can I finance the purchase of an existing business?

You may be surprised to learn that business financing can be a challenge. Bank loans can often take months before they're approved.

A more immediate solution for your capital needs includes potential combinations of seller financing, asset financing, non-bank asset-based lender solutions, and cash flow and asset monetization strategies. Non-bank solutions typically come with higher interest rates but are a more accessible form of capital.

What is Seller Financing in a business acquisition?

Seller Financing allows some business owners to loan buyers the money to buy their business, often reflecting the seller's confidence in the company or a need to incentivize buyers due to a limited market to sell the business.

The decision to offer such financing can be an essential negotiation point. Typically, seller financing won't cover the total purchase price, so buyers must make a down payment, possibly from other personal financing sources. Requirements can vary, but a good credit score is generally expected, though prime borrowing status is unnecessary.

What are the points to consider when buying a business?

When buying a business, these are the essential steps to follow to secure financing :

Conduct Due Diligence: Request and evaluate all critical company documentation on business credit history, including financial statements, tax returns, assets/equipment lists, client and supplier data, employees' records, and necessary contracts. Additionally, assess other elements with material impacts, such as licenses, patents, debts, and specific conditions like lease terms, renewal options, and personal guarantees from landlords, especially if the location is crucial to the business.
Structure the Deal: Negotiate the purchase price, agree on other terms, and determine the financing methods for the acquisition.
Finalize Legalities: Prepare and execute all necessary legal documents to ensure the transaction complies with the law and reflects the agreed-upon terms.

What are the issues to consider When Buying a Business?

Assumption of Debt: Consider buying just assets or the entire business, including assets and liabilities (debt).
Financing Operations upon Purchase: Plan for the funds needed to operate the business after purchase, with multiple financing options:
- Cash Reserve/Self-Funding: Utilize the business's cash reserves; bring in additional money if needed in addition to being prepared to provide a personal guarantee
- Line of Credit: Borrow up to a specific limit, pay interest only on borrowed amount; provides immediate access to funds, similar to business credit cards.
- Invoice Financing: Finance business invoice receivables to improve working capital and meet short-term liquidity needs; includes solutions like invoice discounting and factoring, commonly used by small businesses who are unable to access all the bank credit they require to fund sales and growth

How hard is it to get a loan to buy an existing business, and can you get 100% business acquisition financing?

Depending on several factors, getting a loan to buy an existing business can be challenging. Here's what to consider:

Difficulty in Obtaining a Loan:

Credit Score: Lenders typically require a strong credit history from the buyer.
Business's Financial Health: If the existing company has strong financials, it might be easier to secure a loan.
Industry and Market Conditions: Getting a loan might be more challenging if the industry is considered high-risk or out of favour
Down Payment and Collateral: Some lenders often require a significant down payment or collateral.
Experience in the Industry: A lack of experience might make lenders hesitant.

Can You Get 100% Business Acquisition Financing?

While it is not common, 100% financing for a business acquisition might be possible but is very rare.

Strong Relationship with a Lender: If the buyer has a solid history with a lender, they may be more willing to provide total financing for the business venture
Exceptional Business Opportunity: A lender might consider full financing if the purchased business has solid financials and a proven track record.
Seller Financing: Combining traditional lending with seller financing might allow you to cover a portion purchase price in addition to your equity investment/down payment
Government Programs: Some government-backed loan programs may allow for a higher loan-to-value ratio- such as the Canada Small Business Financing Program

However, even in these cases, 100% financing is rare in the Canadian business landscape and typically comes with stringent requirements, higher interest rates, and closer scrutiny.

It is generally advisable to have a reasonable down payment and to consider a combination of financing options rather than relying solely on a loan for 100% of the purchase price.

Consulting with a Canadian business financing advisor such as 7 Park Avenue Financial, which specializes in business acquisitions, can provide insight into the available options for your particular situation.

WELCOME !