Financing a Business Accusation
Financing a small to medium-size business acquisition, whether you are an investor, or a future owner-operator requires careful planning and preparation. Financial institutions would require to see a solid business case and a carefully planned debt repayment schedules. Consider all possibilities and carefully assess each of them before making your decision.
Thinking about financing a small business purchase should be done at the very beginning of the business acquisition process. If you work with a knowledgeable business broker they should be able to sit down and discuss with you all possible financing scenarios for the business acquisition you are considering. Many buyers are not aware of the programs and financing requirements and often have misconceptions regarding possible leveraging of a business deal. Below are some initial tips.
1. Assess properly how much can you put down towards a business acquisition
Many buyers approach me and tell me, “I look for a business around, say, $750,000.” This is really not how you should start approaching the acquisition process. The question you have to ask yourself and share with your business broker is: “If I have to write a check, what is the amount that I feel comfortable putting towards a business purchase”. Be honest with yourself, because if you are not, or you do not feel comfortable with this number, you will be chasing businesses that are not a good fit. Funds to write a check for a business acquisition are not necessary only cash funds that you have sitting in the bank. This include any other investments and financial assets that are relatively liquid and you can convert to cash. It also includes any home or other real estate equity. Accessing a home equity line of credit is a common way of partially financing a business acquisition. However, make sure you go to your bank prior to exploring a business purchase and pre-qualify for a home equity line. This way you will know in advance of your business purchase what amount and under what terms you can access these funds and compare this cost of capital with the other options you have. You can also speak with a Mortgage Broker or a Banker and discuss whether a Second Mortgage on a real property or a HELOC (Home equity line of credit) is a better option for you.
2. Seller Financing
One of the most common ways of small business purchase financing is the VTB (Vendor Take Back). Usually, a Seller, or Vendor Take Back is a secured promissory note that sets an amount, terms and conditions of a loan that the Seller is to provide to the Buyer. The advantage of a Seller Financing is that it aligns the interests (at least in the short to medium term) of the Buyer and the Seller for successful performance of the business. Seller Financing is a point of negotiation between the parties and there are really no general rules of thumb on the amount as % of the entire transaction. In my experience I have seen VTB of up to 65% of the entire transaction, however, in many cases Sellers are not open to such form of financing. As a Buyer objectively assess the opportunity of Seller Financing and consider its cost and terms against the other options you have. Also, keep in mind that the fact that a Seller does not want to provide financing for a business acquisition does not mean that they do not trust you will be successful, in many cases Sellers just do not want to still maintain involvement in the business to make sure they get paid out. Assess carefully the pros and cons of the Seller Financing option (if available) and do not necessarily insist on it unless it makes financial and business sense.
3. Canada Small Business Financing Loan (CSBFL) Program
Banks, credit unions, and other financial institutions are eligible to make loans under the Canada Small Business Financing Act. The decision to grant or not to grant a loan is up to the lender. Most for profit small and medium size businesses in Canada with gross revenues or projected revenues of less than $5 million are eligible to apply for loans under this program. Such businesses can be corporations, sole proprietors, or partnerships. Loans can finance the cost of the purchase or improvement of real property and immovables, leasehold improvements, and the purchase or improvement of new or used equipment. Financial institutions can finance up to 90% of the cost of asset acquisition or asset improvement. The maximum loan amount a small business can access under this program is $500,000, of which $350,000 can be used to finance the purchase or improvement of equipment and the purchase of leasehold improvements. The interest rate may be variable or fixed. For a variable rate, the maximum chargeable is the lender’s prime lending rate plus 3%. For a fixed rate, the maximum chargeable is the lenders’ single family residential mortgage rate plus 3%.
4. Other Sources of Financing
Besides the above-mentioned financing options, there are a myriad of other types of financing you can access to finance a business acquisition. They include bridge and mezzanine financing, personal lines of credit, and mortgage financing, to name a few.
The moment you have decided that the business you have been looking at is the right business acquisition target, sit down with your business broker and plan out what is the optimal debt to equity structure that makes sense for you as an investor or a business owner. Use this is a starting point in your offer, however, make sure it is a realistic option that you can execute