Understanding Vendor Take-Back (VTB) and Earn-Outs
It is simply the seller's agreement to receive payment for a percentage of the acquisition price at a future point in time.
The bottom line? Less borrowing is required. Structures of the seller finance, also known as 'VTB' or vendor take-back, can vary but often are in the 10-20% range and have various forms of creativity around payment terms. You might also hear this term called 'earn out'.
Three different ways to say the same thing! There might be conditions tied to the earn-out, so in most cases, a lower rate of interest than current market lending rates. It is the epitome of a 'motivated seller'.
In many of the transactions we see at 7 Park Avenue Financial, the seller owner and/or management stays on for an agreed-upon amount of time to ensure a smooth transition. The amount of proper financing that you can generate, internally and externally (mostly externally!), will ultimately play a large part in the size of the company with whom you might be acquiring or merging.
The Importance of Proper Valuation and Financing Structures
Here is where valuations come into play and anywhere from 30 - 50% of the final price that you agree on might have to represent a cash-type scenario. In some cases, there is a shortage of the total term loan to get a transaction approved and closed, so some form of 'mezzanine financing' will have to be considered. That financing will cover the gap created between borrowing power, equity, and the sale price.
Mezzanine Financing to Bridge Gaps in Acquisition Funding
Mezzanine financing is often unsecured, relying solely on future cash flow generation, so interest rates on cash flow loans are more expensive, but, again, similar to seller financing, can make or break a deal. For smaller transactions in Canada, many companies consider the Government of Canada Small Business Loan program as one of the methods of financing acquisitions.
Considering Alternative Financing Options and the Reality of Acquisitions
Naturally, there are a thousand stories in the naked city, as many firms are acquired simply for the reason that they are not profitable for the current owner.
This does bring up a very key point though, which is that if you are looking at acquiring a firm that is in trouble, losing money, losing market share/sales, etc., then in fact a lot less cash is required for the transaction. However, at that point, you'll have other challenges to address. If there is a solid piece of advice we can give to the Canadian business owner and financial manager, it’s to start a financing strategy around your acquisition early on.
The Importance of Early Planning in Acquisition Financing
That final capitalization of the proper amount of debt and equity is critical. When contemplating bank financing for business acquisition financing in Canada, a solid, realistic, and succinct business plan is required. We see many plans from clients that are far less than 'succinct' and therefore raise more questions than answers.
Demonstrating Viability to Lenders: The Role of a Business Plan
So what does one have to demonstrate to the bank?
A good start is how your firm will operate the business - so a good examination of the financials and any key issues around the seasonality of sales and cash flows, customer concentration, production, and credit terms are key. If the business you are acquiring does have challenges, it's a good time to demonstrate how you will implement controls and changes around those challenges.
At 7 Park Avenue Financial, our due diligence process spends a good amount of time on assuming proper levels of sales and cash flow, often in conjunction with a business plan, we prepare to support your transaction.
Spending valuable time on structuring financing for an acquisition will lead to optimal performance going forward. The right amount of flexibility in your finances may be well required down the road.
The Risks and Rewards of Leveraging in Business Acquisitions
Spend a lot of time considering the amount of leverage you will ultimately have when acquisitions are completed.
It's tempting, of course, to become highly leveraged, but this is the classic double-edged sword of business financing, and don’t think that high leverage will guarantee higher returns to shareholders, as that debt you are now carrying can become a day-to-day nightmare down the road if not managed or financed properly.
Conclusion - Optimal Performance Through Structured Financing
Business acquisition financing in Canada is about finding a solid opportunity, analyzing your transaction carefully, and closing with the best financing possible based on your industry profile of debt and overall capitalization.
A Final Thought
Over 60% of small to medium-sized business acquisitions in Canada fail to secure adequate financing on their first attempt, underscoring the critical need for more informed financial strategies and planning
Speak to 7 Park Avenue Financial, a trusted, credible, and experienced Canadian business financing advisor who can assist you with a successful acquisition that makes sense- financially!
FAQ: FREQUENTLY ASKED QUESTIONS PEOPLE ALSO ASK MORE INFORMATION
What is business acquisition financing and how can it benefit my business?
Business acquisition financing refers to the funds specifically raised to acquire another company. This type of financing for the purchase price benefits businesses by providing the necessary capital to expand, enter new markets, or acquire valuable assets without depleting their cash reserves.
How does business acquisition financing work in Canada?
In Canada, business acquisition financing for your optimal financing structure around existing businesses typically involves a mix of debt and equity funding. Entrepreneurs can approach financing via bank loans, as well as private lenders / non-bank private lenders, or use government programs to secure the capital needed for acquisition while maintaining a balance that doesn't overly leverage their existing assets.
What are the key considerations when seeking to secure financing for a business purchase?
Key considerations include understanding the valuation of the target company's existing business, determining the appropriate mix of debt and equity, assessing your repayment capacity, and ensuring the acquisition aligns with your business's long-term strategic goals. In the new economy issues around intellectual property, and intangible assets such as goodwill must be addressed by the buyer.
Can small businesses in Canada access acquisition financing?
Yes, small businesses in Canada have access to acquisition financing. Various programs and lenders cater specifically to the needs of small businesses, including government-backed loans, financing from business-oriented credit unions, and asset-based financing options.
What is the role of due diligence in business acquisition financing?
Due diligence is a critical process in acquisition financing, involving a thorough examination of the target company's financial statements, legal standing, market position, and operational efficiency. It helps in assessing the feasibility and potential value of the acquisition.
What factors influence the interest rates on business acquisition loans in Canada?
Interest rates on business acquisition loans in Canada are influenced by factors such as the creditworthiness of the borrowing business, market conditions, the size and terms of the loan, and the lender's risk assessment of the acquisition deal.
Are there specific industries in Canada that benefit more from acquisition financing?
While business acquisition financing is available across various industries, sectors with high growth potential, stable cash flows, and scalable operations, like technology, healthcare, and manufacturing, often see more benefits due to their attractive return on investment prospects.
How long does the process of securing business acquisition financing typically take?
The time frame for securing business acquisition financing can vary widely, typically ranging from a few weeks to several months, depending on the complexity of the acquisition, the amount of financing required, and the thoroughness of the due diligence process.
Can a business use acquisition financing to purchase a competitor in Canada?
Yes, businesses can use acquisition financing to purchase a competitor, allowing them to expand their market share, access new customer bases, and achieve economies of scale. This strategy is often used for consolidating market positions in competitive industries.
What impact does a business's credit history have on acquisition financing approval?
A business's credit history plays a significant role in acquisition financing approval. A strong credit history can lead to more favorable loan terms and lower interest rates, while a poor credit history may result in higher costs or even difficulty in securing financing.
What are the differences between equity and debt financing in business acquisitions?
Equity financing involves selling a part of the business's ownership in exchange for funding, while debt financing means borrowing money to be repaid with interest. In acquisitions, equity financing can dilute ownership but doesn't require repayments, whereas debt financing retains full ownership but adds the burden of repayment.
How can a business prepare for the acquisition financing process?
To prepare for acquisition financing, businesses should gather comprehensive financial records, conduct internal financial audits, prepare a solid business plan highlighting the acquisition's strategic value, and conduct preliminary due diligence on the target company to assess risks and opportunities.
What are common mistakes to avoid in business acquisition financing?
Common mistakes include underestimating the total cost of acquisition, failing to conduct thorough due diligence, neglecting the integration process post-acquisition, underestimating the importance of a balanced financing mix, and overlooking the impact of the acquisition on existing operations and cash flow. Avoiding these mistakes can lead to a more successful and sustainable acquisition.
