When it comes down to it, how do you actually buy your target business—the enterprise of your eye that has significant cash flow and exciting potential?
The answer is: through the fruition of a perfected financing package.
A good financial package is your passport to a successful acquisition and prosperous business ownership.
The BDC, Canada’s trusted bank for entrepreneurs states, “The right capital structure,” for an acquisition, “will make the transition smoother and position your business for more growth.”
For more information on how to craft an effective and affordable financing package, read our article here.
What Does Your Financing Package Include?
Before a buyer can craft their financial strategy, they need to be aware of the financing options available.
Here are 3 main financing options for acquisition entrepreneurs in Canada:
* Keep in mind: when financing an acquisition, buyers commonly utilize a blended financing package that incorporates each type of the following financing strategies.
1. Cash Investment
What is a cash investment?
The cash investment is the amount of liquid money that the buyer directly pays to purchase the business. It’s like a buyer’s down payment.
Cash investments are typically sourced from:
A buyer’s personal wealth and savings
Gifted capital pooled from family or friends
Third party investors
Silent business partners
How might the cash investment apply to your acquisition?
Every acquisition begins with a portion of self-funded financing.
According to the BDC, the average buyer puts down a cash investment “to cover 20% to 30% of the purchase price.” That said, when a buyer contributes a higher percentage of cash investment, it incentivises lenders to see you as a committed entrepreneur with a strategy worth their investment risk.
Ultimately, as the BDC articulates, “equity participation lowers the financing amount and shows the shareholders’ commitment to the acquisition.”
2. Lender Financing
What is lender financing?
Lender financing is also referred to as senior debt. It is the bank loan obtained by the buyer.
Banks will loan entrepreneurs capital once they’ve assessed the risk, EBITDA and overall value of an acquisition. The loans available vary depending on the lending institution—terms and conditions of the loan amortization, payback schedule and interest rates also vary according to the specificities of the acquisition and the loaning institution. But, as with any loan, the terms of lender financing are strict, yet they’re essential for the maintenance of most businesses. Typically, even with small business acquisitions, buyers do not have the funds to finance the acquisition themselves—lender financing helps buyers access capital to grow their businesses.
How might lender financing apply to you?
According to the BDC, senior debt makes up “the bulk of the financing package” for most acquisitions.
“The senior lender in an acquisition deal provides a loan secured against the assets of the company.”
A significant portion of lender financing is determined by the value of your target business’ tangible assets (eg. real estate, inventory and equipment).
A lesser portion of lender financing is determined by the value of your target company’s goodwill (eg. customer reach, intellectual property and reputation).
Because of the risk involved in acquisition, senior lenders are more likely to supply substantial loans to entrepreneurs with 5 plus years of industry experience related to their target business.
3. Vendor Financing
What is vendor financing?
Vendor debt equates to seller financing or vendor take back. It’s a type of acquisition loan that is provided by the target business’ seller instead of a financial institution. In this case, the vendor agrees to finance a portion of the business purchase.
As the BDC states, this form of financing, “is sometimes seen as patient capital because it typically is not secured on the assets of the company.” In addition, the buyer (new business owner) pays the vendor back at a later date either through an interest-based repayment schedule or in a one-time lump sum. Vendor financing can be appealing to sellers because it can assist in a seamless transition of ownership and can advance negotiations to close deals at a quicker pace.
How might vendor financing apply to your acquisition?
According to the BDC, “vendor financing typically amounts to 10 to 15%,” of an acquisition’s financing package.” Vendor debt supplements buyers with necessary funds that traditional lenders such as banks may not be willing to offer them. Likewise, the terms and conditions of vendor take back loans are not as stringent as institutional loans with shorter repayment terms and lower interest rates.
“Beyond providing financing, seller debt creates an economic incentive for the seller to help the business succeed after its sale.” — Richard S. Ruback and Royce Yudkoff in HBR Guide to Buying a Small Business
Many acquisitions require that the seller remain involved in the company post-transaction. With vendor financing, sellers can be positioned to work for the company as an or consultant, which is useful for ownership transition.
Here at Village Wellth, we want buyers to be aware of the options available to them. By increasing their buyer awareness, buyers make meaningful and informed financial decisions that will ultimately support the success of their acquisitions and new ownerships.
Village Wellth’s community of leading CPAs and financial professionals work closely with buyers to provide you with the guidance you need to craft a creative financial strategy that’s capable of fostering long term growth and success for your newly acquired business.