Acquiring a business: What financing package is best for you?

Contrary to popular belief, there is no one-size-fits-all financial product for business acquisitions and transfers. Depending on the recommended package, many types of financing will be available to the parties to the transaction. You are the architect of your business acquisition project, so it's up to you to draw up the plans.

Preparing a good business plan is an objective way of ensuring all the pieces are in place, including the financing. That's why you should work with a number of different partners, including financing specialists.

Along with your business plan, you should provide your business's financial statements (past 5 years) and financial forecasts, including:

• details of the project and the financing package under consideration
• working capital and investments in tangible and intangible assets needed for business development
• a post-transaction opening balance sheet
• income statement, cash flow and projected balance sheets for the next 3 years with the first year broken down by month
• the buyer or buyers' personal balance sheet

To learn more, see the Desjardins interactive business plan.

Types of financing

Generally speaking, business transfers are financed with loans or equity or through a public or semi-public financing program.

Loan financing

Loans are generally used to finance accounts receivable, inventory and the purchase or renovation of equipment and commercial property.

Equity financing

Equity is considered non-traditional financing. It is often provided by investment companies like Capital régional et coopératif Desjardins and other funds supporting business succession projects.

These companies have attractive financing solutions for business owners who want to ensure the long-term success of their Quebec businesses. They invest in SMEs with varying financial needs in the form of debt or capital stock. As part of a buyout, employees can also become shareholders with a stake in the business's performance by setting up an employee shareholder cooperative.

Public and semi-public financing programs

The federal and provincial governments offer various subsidies to help businesses succeed and to promote entrepreneurship, including:

• Fonds Relève Québec, which helps buyers double their investments in business transfers. This novel form of financing requires no tangible guarantee on the part of the borrower or group of borrowers, with the exception of the shares financed by the loan. Loans range from $50,000 to $500,000.
• Prêt à entreprendre, a program that supports Quebec's most promising new entrepreneurs. It offers comprehensive assistance to entrepreneurs through interest-free, unsecured loans of up to $30,000, along with mentoring and technical support.
• Fonds d'investissement pour la relève agricole, which offers between $50,000 and $500,000 in patient capital to young farming entrepreneurs with start-up, establishment and arable land lease projects.

Cash flow–based financing

On the risk curve, this type of financing falls somewhere between conventional debt, which is based on a normal percentage of business asset financing, and quasi-equity products, which are mainly unsecured and based exclusively on the business's financial performance.

This type of financing is usually reserved for businesses that can demonstrate low cash flow volatility and good management and financial performance. The financing amount generally exceeds the loan value of the guarantees, so buyers can get lower interest rates than they would on subordinated debt.

Cash flow–based financing can be used for the following types of transactions:

• Manager stock redemptions
• Intergenerational transfers
• Dividend payments as part of pre-transfer tax planning
• Acquisitions to grow businesses in accordance with the financial objectives of the future transferors

Considerations: Before opting for this financing approach, entrepreneurs must gain a solid understanding of the specificities of the business they intend to acquire and determine what capital assets are needed to maintain current earning levels in the future.

Other data must also be considered:

• Historical profitability and cash flow stability
• Management team competence, the plan to transfer management responsibilities from transferor to buyer, and the ability to execute the transition plan
• The business's strategic positioning and products and services development
• The industry's business cycle and outlook
• The price paid for the business
• The ability to pay fixed costs (principal, interest, capital reinvestment) based on the business's typical cash flow
• The quality and value of the guarantees

Financial ratios: The financial framework in which the business will operate after the transfer transaction is determined by financial ratios. The goal is to strike the right balance between the buyer or buyers' freedom to run the business and the risk constraints of the transaction's financial partners. The ratios used most often for this financing approach are tied to the business's financial performance, i.e., the interest-bearing debt ratio, EBITDA (earnings before interest, tax, depreciation and amortization) and the fixed-charge coverage ratio (principal, interest, capital reinvestment and taxes), and finally a liquidity ratio, i.e., the current ratio.

It is essential that you plan out the process of financing your business project with the parties involved in the transaction and their experts. You need to tell your lender who is on your team of experts so they can work together throughout the process. A business acquisition is a transaction that comes with a whole host of legal, insurance, personal and business tax, business valuation, financing and coaching considerations.