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Understanding Business Acquisition Loans : How to Buy a Business | 7 Park Avenue Financial
BUSINESS ACQUISITION LOANS
TABLE OF CONTENTS
Introduction to Business Acquisition in Canada
What is a Business Acquisition Loan?
The Right Capital Structure is Key
What Type of Financing Do You Need?
Understanding What Lenders are Looking For
Putting the Valuation on the Business You are Purchasing
Buyer Commitment / Down Payment: Your Equity Contribution
Senior Debt - The Most Critical Aspect of Your Financing
Choosing the Best Business Acquisition Loan for Your Needs
Vendor Financing: The Seller Note Solution via the Current Business Owner
Closing the Gap - The Mezzanine Financing Solution
Government Loans for a Business Purchase
Check Your Eligibility
Asset-Based Lending / Leveraging the Assets!
Do...Your Due Diligence!
Post-Acquisition Financing Needs?
Conclusion - Business Acquisition Financing: Talk to the Experts
FAQ
INTRODUCTION
Buying a business in Canada is the perfect way to quickly a client base, increase the existing capacity of an established business or company, or gain access to new markets. Some entrepreneurs even focus on acquiring a competitor or supplier!
WHAT IS A BUSINESS ACQUISITION LOAN?
A business acquisition loan is a specialized form of financing explicitly designed to purchase an existing business or franchise. These loans can be sourced from traditional bank loan solutions, credit unions online lenders, or specialty finance institutions. They can be secured or unsecured, and the structure, terms, and rates can vary widely depending on the lender, the financial health of the business being acquired, and the buyer's financial situation.
Acquisitions are a part of business life, but how does financing the business purchase work? Sometimes, a company is too small for some lenders to consider an acquisition deal, but that doesn’t mean a business financing solution exists.
Combining an existing company with another to expand is also a great way of increasing your current business’s success. However, if you want the acquisition to be successful, ensure you are working with a business financing expert.
Numerous critical issues around your financing need to be addressed, including appropriate funding for fixed assets and, in some cases, company-owned commercial real estate. Long-term financing of certain assets will be very beneficial in the long run - at the opposite end of the spectrum, if the business has intangible assets that can sometimes, but not always, be a challenge.
THE RIGHT CAPITAL STRUCTURE IS KEY
The right capital structure will position your business for continued growth and make the transition around the business purchase smoother while presenting more opportunities for success.
The proper financing structure can make all the difference. When buying a company, it's essential to understand how each type of loan works and find the perfect mix for your needs to help guarantee future success.
WHAT TYPE OF FINANCING DO YOU NEED?
Financing will often come down to either term financing of some sort, or cash flow financing.
UNDERSTANDING WHAT LENDERS ARE LOOKING FOR
Cash flow financing allows businesses without sufficient tangible or significant intangible assets to finance an acquisition. This type of debt is based on the company's capacity for debt service and interest coverage, which is essentially judged by its performance in past years as well as through projected future results.
A reasonable acquisition price based on the valuation method is vital to any business purchase. The company must also have proven capacity to generate enough profit to cover debt service obligations and the need for future capital expenditures as deemed by competent management!
PUTTING THE VALUATION ON THE BUSINESS YOU ARE PURCHASING
One of the first tasks when trying to buy a company is determining its value. This can be not easy because many factors determine how profitable a company has been or can be. To represent future cash flow and earning potential accurately, a buyer needs to carefully ' normalize ' the financials to reflect new ownership -
Here is where detailed 'micro analytics ' around your due diligence pays off! Often, averaging several years of cash flow generation is an excellent tool.
In many cases, particularly in larger transactions, sellers or buyers may enlist the help of a professional business valuator, commonly known as a chartered business valuator. Anyone with proper experience will look at performance around operating cash flows, rates of return, and return on investment, all of which can be tied to the business's growth potential.
Every industry or economic sector in Canada has issues around competitiveness, profits, and the need for additional assets or technology. Sometimes, a business may have recurring revenue, which is almost always considered a plus.
As a buyer, you want a recent return on your business at an acceptable purchase price/valuation.
There is no perfect way to determine the value of your target company, but you can often use cash flow as a starting point. Other areas to focus on are depreciation policies, taxes, and the timing of expenses. In some cases, significant investments made recently will have long-term benefits seen later on down the road.
BUYER COMMITMENT / DOWN PAYMENT: YOUR EQUITY CONTRIBUTION
The equity portion you put into the business, of course, decreases the amount needed to be borrowed, demonstrates your commitment to your deal, as well as helping to lead to a successful acquisition.
SENIOR DEBT - THE MOST CRITICAL ASPECT OF YOUR FINANCING
The senior lender in any acquisition deal provides a loan secured on your company's assets. While specific items may not fully guarantee this amount, it's called senior debt because there is a first charge on all assets. In Canada, lenders typically register a ' GSA ' ( general security agreement ), giving them a first charge/priority on present and future assets via the loan agreement and its stringent loan requirements from traditional financial institutions.
CHOOSING THE BEST BUSINESS ACQUISITION LOAN FOR YOUR NEEDS
Senior lenders have priority over other creditors when liquidating a business. They will most often have in place specific restrictive terms and conditions of repayment - these are called covenants and often involve specific ratios in the financial statements.
VENDOR FINANCING: THE SELLER NOTE SOLUTION
It's not uncommon for sellers to help finance their purchase with a note, sometimes referred to as a seller note or ' VTV ' - Vendor take back from the seller.
The seller agrees that they will be paid back over time, and in many cases, this is done through an incentivized deal where bonuses or other incentives are offered.
This financing, also called an ' earn-out ', is a popular way for buyers to compensate sellers of a business; it is sometimes based on how much profit or loss a company produces during the repayment period.
Vendor notes offer many benefits for buyers because they don't come with many conditions similar to senior lender conditions, and the interest cost is usually low. Plus, if purchasers face trouble repaying, the vendor will often cooperate.
CLOSING THE GAP - THE MEZZANINE FINANCING SOLUTION
Mezzanine financing, also called cash flow finance, can be a flexible option for those looking to fill any gaps in their finances of business purchase to achieve the optimal financing structure.
Mezzanine funding can be an excellent solution for bridging the gap between buyer investment and any available financing from bank loans, for example. The interest rates can be lower than those on traditional loans, which makes this deal more attractive in some instances. Typical structures are 3-5-year term amortizations.
Mezzanine financing is sometimes called 'patient financing, 'as the company needs to have its cash flow available for repayment to senior lenders while it executes a growth strategy.
GOVERNMENT LOANS FOR A BUSINESS PURCHASE
Borrowers will find that not all banks or lenders they might deal with for traditional bank loans will be keen on providing loans for business acquisitions - this will include a business-oriented credit union. - Personal finances should be in order with a good credit history and credit score.
CHECK YOUR ELIGIBILITY
For smaller transactions, the Canada Small Business Financing Program 'CSBFP ' will finance existing business purchases, including franchise financing. Talk to the 7 Park Avenue Financial team about how this program works, including eligibility criteria and info on loan payments tailored to your transaction size. This term loan is based on your historical and forecasted cash flow and your ability to make debt payments. A limited personal guarantee is required on the transaction - not for the full loan.
No personal assets are taken in government small business loan financing.
Financing options for government loans can include long-term loans based on the value of fixed assets such as land or buildings. Now, SBL Loans can finance working capital, intellectual property, or leverage existing resources, etc. Talk to the 7 Park Avenue Financial team about the Business Development Bank solutions in this area. Many prospective small business owners will find government loans a suitable solution.
ASSET-BASED LENDING / LEVERAGING THE ASSETS!
Leveraged buyouts and asset-based financing solutions are quite common as business acquisitions for firms with substantial assets relative to financing needs. In this financing structure, you leverage assets (equipment or property, accounts receivable / inventory ) to finance the acquisition with a commercial loan, typically via a non-bank lender.
Seller financing can also be utilized in these types of ' ABL ' deals.
DO...YOUR DUE DILIGENCE!
Due diligence means carefully examining a company's financial statements, income tax returns, and additional information to make an informed decision about your business purchase.
The value of tangible assets (equipment, inventory, buildings, etc.) should be properly adjudicated. As a buyer, you should request everything that has a material impact on the business before making an offer. Focus on profits, the ability to forecast reasonable growth potential, and areas for potential improvement. Incorporate such ideas into a detailed business plan with proper financial projections that can be defended and are conservative and realistic.
7 Park Avenue Financial prepares business plans that meet and exceed the requirements of banks, non-bank commercial lenders, and finance companies.
A proper level of due diligence will make your purchase offer more sound and appealing to a lender / lenders.
POST-ACQUISITION FINANCING NEEDS?
Financing Operations upon the Purchase: The purchase of a business always comes with some level of future financial needs and consideration to obtain financing. You will have multiple options for financing operations after purchasing your new company: cash reserves or self-funding, business lines of credit, sales leasebacks, etc. Business credit cards or a business line of credit are helpful for businesses with immediate access to funds at a set limit, and you only pay interest on funds you draw.
Invoice financing is an arrangement that allows a business to finance its business sales via the financing of invoice receivables. Small companies mostly use it to improve working capital and cash flow without a term business loan. There are two leading solutions - traditional factoring and Confidential Receivable Financing.
CONCLUSION - BUSINESS ACQUISITION FINANCING
TALK TO THE EXPERTS
Let the 7 Park Avenue Financial team, a trusted, credible, and experienced Canadian business financing firm, want to be your partner in financing your loan application.
We will demonstrate customized solutions tailored uniquely to your business purchase needs and requirements around the target business credit score so that you can know that your investment and optimal loan structure will lead to business success without surprises. Guaranteed the ability to secure financing for the business acquisition you are contemplating.
FAQ
What criteria do lenders look at when considering a business acquisition loan?
Lenders evaluate several factors before approving a business acquisition loan:
• Buyer's credit history and financial stability: A good personal credit score and solid financial background can increase the likelihood of approval.
• Business's financial performance: Lenders will want to review the business's financial statements, including profit and loss statements, balance sheets, and cash flow statements, to evaluate its profitability and stability.
• Down payment: Generally, lenders expect buyers to put down a percentage of the purchase price. The required down payment can vary, but it's often between 10% and 25%.
• Experience: Lenders may favour applicants with experience in the industry or in managing a business.
• Collateral: For secured loans, lenders will require some form of collateral, which could be assets of the business or other personal assets.
How do business acquisition loans differ from traditional business loans?
While both types of loans provide financing for business-related expenses, business acquisition loans are intended explicitly for purchasing an existing business or franchise. As such, the approval process for an acquisition loan may involve deeper scrutiny of the target business's financials, history, industry trends, and associated risks. In contrast, traditional business loans are generally used for various purposes, such as expansion, purchasing equipment, or funding day-to-day operations.
How can a potential buyer determine the right price for a business?
Determining the right price involves research, financial analysis, and sometimes professional assistance. Key steps include:
• Financial analysis: Reviewing the business's financial statements to evaluate profitability, debt, assets, and liabilities.
• Market analysis: Comparing the business's asking price with similar businesses in the market.
• Projected earnings: Estimating the business's potential and growth prospects.
• Intangible factors: Considering non-tangible elements like brand reputation, customer loyalty, and intellectual property.
• Professional valuation: Hiring a business valuation expert can provide an unbiased assessment of the business's worth.
Are there any potential pitfalls to watch out for when using a loan to buy a business?
Yes, here are a few pitfalls:
• Over-leveraging: Borrowing more than you can afford to repay can put both the business and your assets at risk.
• Not conducting due diligence: Failing to thoroughly investigate the business's finances, operations, and market position can lead to overpaying or inheriting undisclosed liabilities.
• Restrictive loan terms: Some loans come with stringent terms or covenants that limit business flexibility.
• Focusing only on interest rates: While rates are essential, consider loan terms, fees, and the lender's reputation and customer service.
What's the difference between secured and unsecured business acquisition loans?
Secured business acquisition loans require collateral, such as real estate, equipment, or other tangible assets, to guarantee the loan. If the borrower defaults on the loan, the lender has the right to seize and liquidate the collateral to recoup their funds. On the other hand, unsecured loans don't require collateral but typically have higher interest rates due to the increased risk to the lender. Approval for unsecured loans is often based on the borrower's creditworthiness and the financial health of the business being acquired.
Are there any potential tax implications to be aware of when financing a business acquisition?
Answer: How an acquisition is structured can have tax implications for both the buyer and seller. For instance, buying the assets of a business as opposed to its stock might have different tax consequences. It's crucial to consult with a tax advisor or accountant to understand the potential tax liabilities and benefits before finalizing the acquisition.
How does due diligence for a business acquisition loan differ from the due diligence for other business loan types?
Due diligence for a business acquisition loan focuses extensively on the target business's financial health, operations, and potential risks. It involves deeply reviewing financial statements, asset valuations, legal matters, operational processes, and industry trends. For other types of business loans, the emphasis might be more on the borrowing company's creditworthiness, repayment capability, and intended use of the funds.
Can the terms of a business acquisition loan be renegotiated after the purchase?
Answer: It's generally challenging to renegotiate loan terms after the purchase has been finalized, as the initial terms were based on risk assessments and valuations at the time of approval. However, some lenders might be open to discussions if there are significant changes in circumstances or if the business performs exceptionally well. Maintaining transparent communication with the lender and providing valid reasons for any renegotiation is essential.
What happens if the acquired business underperforms after the purchase?
If the acquired business underperforms, it could jeopardize the buyer's ability to repay loan debts. The buyer should communicate any challenges with the lender promptly. Lenders might offer solutions such as restructuring the loan, adjusting payment terms, or providing additional advisory support. However, in the worst-case scenario, if the borrower defaults and the loan is secured, the lender might seize the collateral to recover the funds.
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