How to Finance Buying a Business: Strategic Options | 7 Park Avenue Financial

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 BUSINESS PURCHASE  ACQUISITION FINANCING   

When deciding to buy or expand your business, you may have many questions. This information will help you find the answers and assist in guiding you through the process of purchasing a company. It will also provide key issues before focusing on external financing around a business sale.

Many buyers who seek to buy a company often underestimate the importance of raising the right amount and type of financing!

Businesses in unfamiliar fields are challenging to succeed with.

Before buying a business, evaluate your skills and interests. Choose one that matches these attributes to reduce the risk of failure and achieve success more effectively.

Navigating the Business Acquisition Financing Maze

Are you dreaming of business ownership but facing the financing hurdle? Many potential buyers identify ideal acquisition targets only to discover that securing capital is far more complex than anticipated.

Canadian lenders have tightened requirements, making traditional financing increasingly difficult to obtain.

Let the 7 Park Avenue Financial teams show you how various financing strategies exist beyond conventional bank loans, allowing savvy entrepreneurs to structure deals that benefit both buyer and seller.

Uncommon Takes on Financing Business Acquisitions

1. Earn-Out Financing: Rather than securing full financing upfront, negotiate a performance-based payment structure where a portion of the purchase price is paid from future earnings. This reduces initial capital requirements while aligning seller interests with your post-acquisition success.
2. Inventory-Backed Financing: For inventory-heavy businesses, specialized lenders offer financing secured by the target company's inventory, often overlooked by traditional lenders but representing significant collateral value.

THE CHALLENGE OF FINANCING A BUSINESS PURCHASE 

To finance a business purchase, you must also ensure your personal finances and assets are in good shape.

Address this key point before making the decision to purchase a company. You want to acquire the right business and minimize the depletion of personal savings.

Are you looking for some additional assistance in financing your acquisition?

When you purchase a business, there are many things to consider. One of those factors is whether or not the seller will finance some portion (or all) of your purchase price via some form of debt repayment over time;

This seller financing effectively lets them defer payment on the business purchase for an agreed-upon amount while still being able to access the funding from other sources to complete the transaction.

As with any deal,' seller note / vtb terms ' tend to be negotiable depending on how confident both parties feel about each other's ability to run the business post-takeover.

Vendor financing can be a great way to get the business up and running and can often help finance the ' goodwill'  or ' intellectual property ' portion of your transaction.

"Seller debt" has many benefits over traditional bank loans, with typically lower interest rates before investing their money into the transaction.  The terms will depend largely upon your needs as well-

A Typical Example :

Knowing what type of loan you will take out is essential when financing a purchase. A typical pro forma capital structure might be 30% cash equity, 20% seller note, and 50% bank or commercial finance firm financing via alternative lenders.

When looking for a business to buy, focus on one with stable profits and the following attributes: good sales volumes, a brand, and industry reputation, as well as the ability to compete in its industry.

Loans for business acquisitions come in many different forms. Still, after the founder's investment and loans from friends or family, a business acquisition loan will likely be necessary—typically a term loan supported by cash flow. There are several types of lenders who specialize exclusively in providing these types of financing opportunities. Understanding which financial institution is best for your deal is key when focusing on debt financing.

The Canadian Small Business Financing Program is a great way for banks in Canada to finance the purchase or improvement of small businesses via a bank loan in a term loan structure—namely, firms with less than 10 million in revenues. The program guarantees that small business owners will get credit and very competitive interest rates on smaller transactions, with less reliance on equity financing when it comes to small business finance.

Venture capital firms are typically not the best sources for the SME sector to fund the purchase of an existing business.

FIGURE OUT THE POTEMKIN VILLAGE ISSUE!

Some potential problems could make the business less attractive than it initially seems. It is important to look for and avoid these problems because you may incur many unplanned costs.

Unforeseen issues with a business purchase can make the original deal less attractive. Due diligence will allow for research into these problems and avoid future costs.

THE POTEMKIN VILLAGE ANALOGY?!

There is a great analogy some business folks refer to as the ' Potemkin Village ' issue. In the 18th century, Prince Potemkin set up fake settlements to fool his lover during her journey through Russia.

After she passed away from injuries sustained when their carriage fell down an incline along with other passengers on board (to avoid being seen by anyone), he had these ostensible communities torn down and reassembled farther away from where they were originally built so that no one would know what happened there initially. This act earned him praise and titles such as “The Builder."

The bottom line is to look for things in the business acquisition target that might not be as they seem!!!

YOUR FINANCIAL DUE DILIGENCE

Have you ever considered the consequences if your business suddenly and drastically reduced size? Would losing a single customer or supplier devastate you?

Does revenue come from market growth, price increases, or new products? You don't want to operate in an industry where competitors can easily steal clients away! Are there concentration concerns related to business revenue around suppliers or the customer base?

Carefully examine business records such as financial statements ( audited is preferred but not always available ), tax returns from the last three years, and interim statements to ensure their accuracy before making any decisions based on them and proceeding to acquire a business loan.

Examining the ' seller’s discretionary income 'closely is essential, as it may indicate unnecessary personal expenses or sweetheart deals that will end when the current owner sells.

Look for one-time gains buried in operating Income—do these seem suspect? You should also consider monthly sales numbers over a few years; if they're cyclical, then maybe now isn't precisely their peak time.

Lastly, spend a sufficient amount of time normalizing the financials so that they will look post-acquisition.

Accounts receivable aging is an essential indicator of a company's health and financial soundness.

Days sales outstanding (DSO) tells you how long it will take to collect what's been invoiced, while average daily revenue is another good measure to examine. A lower DSO should reflect good collections and be benchmarked against the terms offered to the client base.

Conversely, DPO, or 'Days payable,'  measures the number of days it takes for a payment to be made.

There are many types of liens, including PPSA  and tax lien certificates. These can be reflected in financial statement notes and potentially on the balance sheet, but they also have an off-balance-sheet effect.

The key to successful integration is understanding what your business purchase acquisition will allow you to do.

If possible, look for synergy in products, services, and marketing/sales methods so they complement or relate!

Marketing must also mesh with delivery systems such as production capacity; this ensures that staff from both firms can be integrated smoothly into existing operations without issue.

 TRANSITIONS AND NON-COMPETE   

In your business purchase strategy, it may also help if sellers agree not just on a non-compete agreement but also on signing transition periods during which they will still provide some assistance during this process.

You should identify potential business pitfalls before it's too late.

An experienced lawyer can help with this task by reviewing all legal documents, such as articles of incorporation or trademark registration procedures, and asking for their input on future contracts that may affect your new business if something goes wrong later down the line (e.g., change control provisions).

Case Study: Benefits of Strategic Business Acquisition Financing

When a Canadian buyer identified a profitable manufacturing business for sale in Ontario, the $2.8 million price tag initially seemed insurmountable. The company showed strong fundamentals, with consistent cash flow, loyal customers, and valuable equipment. Still, traditional banks would only finance 50% of the purchase price, requiring a $1.4 million down payment the buyer didn't have.

Rather than abandoning the opportunity, the buyer implemented a creative financing strategy. He negotiated with the seller to retain 30% of the purchase price ($840,000) as seller financing with a five-year term. With this seller commitment secured, a specialized business acquisition lender agreed to provide 60% of the purchase price ($1.68 million) with a 10-year term. The remaining 10% ($280,000) came from personal funds and savings and a small investment from a family member.

KEY  TAKEAWAYS  

• Accurate Business Valuation forms the foundation of any successful acquisition financing strategy, ensuring you neither overpay nor underestimate capital requirements.
• Seller Financing often represents the difference between closing a deal and walking away, providing flexible terms unavailable through institutional lenders.
• Maintaining Adequate Post-Acquisition Working Capital prevents cash flow problems when unexpected expenses frequently arise during transition.
• Advance Preparation of comprehensive financial documentation dramatically increases approval rates with lenders and reduces financing timelines.
• Creative Deal Structuring using earnouts, performance-based payments, and royalty arrangements can significantly reduce upfront capital requirements.
• Leveraging Government-Backed Small Business Loans specifically designed for business acquisitions provides access to longer terms and lower down payment requirements.
• Understanding industry-specific financing sources specialized in your sector can unlock unavailable financing options through generalist lenders.

CONCLUSION 

Let 7 Park Avenue Financial help you buy a business successfully! And with the optimal finance structure!

We're business professionals and a trusted, credible, and experienced Canadian business financial advisor. We'll help you analyze the value, negotiate the best terms, and, most importantly, close the deal!

We'll prepare a business plan that meets and exceeds the requirements of banks and other commercial lenders/alternative lenders and will help secure financing successfully with the right lending institution.

FAQ: FREQUENTLY ASKED QUESTIONS / MORE INFORMATION

What is a letter of intent?

The Letter of Intent outlines the terms for a purchase between two parties before finalizing it. When purchasing a business, you’ll sign an LOI and likely a Confidentiality Agreement to conduct your final due diligence before proposing final terms.

What financing options are available when buying an established business in Canada?

Financing options include traditional bank loans, Government SBL loans, seller financing, leveraged buyouts, equity investors, mezzanine financing, asset-based lending, and family office investments. The best choice depends on your financial situation, the business's performance history, and available collateral.

How much of a down payment is typically required when financing a business purchase?

Most lenders require 20-30% of the purchase price as a down payment when financing a business acquisition. However, this percentage can vary based on the business's stability, historical profitability, industry type, and your personal creditworthiness.

Can I use the business's assets as collateral to finance the acquisition?

Asset-based lending allows you to leverage the target business's equipment, inventory, accounts receivable, and real estate as collateral. This approach is particularly valuable when acquiring asset-rich companies with limited cash flow history or lacking sufficient personal assets for collateral.

What role does seller financing play in business acquisition transactions?

Seller financing typically covers 15-60% of the purchase price and demonstrates the seller's confidence in the business's future performance. This financing method often features more flexible terms than traditional loans and can bridge gaps when bank financing falls short of the full purchase amount.

How can I determine the right mix of equity and debt when financing a business acquisition?

The ideal financing structure balances minimizing personal risk with maintaining operational flexibility post-acquisition. Most successful acquisitions use 40-60% debt and 40-60% equity, ensuring the business can service debt obligations while maintaining adequate working capital for growth

How does seller financing benefit business buyers beyond just providing funds?

Seller financing offers numerous advantages beyond capital access. The seller maintains a vested interest in your success, often resulting in a more thorough transition period and ongoing consultation. Terms are typically more flexible than bank financing, with fewer covenants and reporting requirements. Additionally, seller financing signals confidence in the business's future performance to other potential lenders, making additional financing easier to secure.

What factors do lenders evaluate when considering business acquisition loan applications?

Lenders primarily assess the business's historical cash flow, typically requiring a debt service coverage ratio of at least 1.25x. Your minimum credit score of 650, industry experience, and management capabilities significantly impact approval decisions. The business's asset quality, customer concentration, industry outlook, and transition risk are also thoroughly evaluated. Lenders look favourably on deals with substantial seller financing, demonstrating the seller's confidence in future performance.

How important is working capital planning when financing a business purchase?

Working capital planning is critical yet frequently overlooked in acquisition financing. Insufficient working capital after closing can force new owners to cut corners, delay vendor payments, or seek expensive emergency financing. A comprehensive working capital analysis should account for seasonality, vendor payment terms, customer payment cycles, and potential transition disruptions. Experts recommend securing an additional 10-20% beyond the purchase price specifically for working capital to ensure smooth operations during the ownership transition.