Understanding the multiple sources of Financing for your Business

Acquiring a business often requires multiple sources of financing. This can be a complex undertaking, especially in cases when more than $500,000 is needed. In most cases, there are four types of lenders and investors willing to finance an acquisition.

Lenders interested in fixed assets

Acquiring a business often involves the purchase of buildings or equipment. Your tax advisor might suggest you take out a separate bank loan for this part of the project, either from your bank or jointly with other financial institutions.

The Canada Small Business Financing Program makes it easier for small businesses to obtain financing from banks up to a maximum value of $500,000, of which $350,000 can be used to finance the purchase or improvement of equipment and the purchase of leasehold improvements.

Lenders interested in the whole package

BDC often supports expansion projects with term financing. Unlike conventional bank loans, this formula allows flexible repayment terms. Another advantage is that a BDC loan will not be called without a valid reason.

Companies that have a competitive advantage in a fast-growing industry should consider subordinate financing. Under this formula, financial institutions lend higher amounts than they would under other circumstances and accept subordinate security in return. But such arrangements will always require a higher return for the lender, who may also ask for royalties on future sales or stock options.

Equity investors

Depending on your situation and the amount you need to raise, you can seek out venture capital from investment banks, institutional investors and mutual or labour-sponsored funds. Your new financier will become a major financial partner, taking an ownership stake in your company and the right to name some members of your board in exchange for a significant injection of capital. Industry Canada's web site has more information on this subject.

Venture capital firms invest across all sectors of the economy but target only businesses with excellent growth potential. Sometimes technology-oriented venture capital companies also consider outright acquisitions. For example, they will look favorably on buying a leading-edge business with products almost ready to put to market that would complement a more mature company's product line.

Strategic investors

These investors focus on certain types of businesses and are often faster than others to grasp developments within a particular industry. These are often groups of professionals from the same industry who keep close tabs on their market and are therefore quicker to recognize risks and opportunities. Major corporations also sometimes acquire equity in companies whose growth they believe it is in their interest to support. The goal can be to exploit a promising niche in their industry, for example, or to improve their firms' technological know-how. Regardless of the type of financing you have in mind, management consulting companies and accounting firms specializing in acquisitions can provide invaluable outside advice. Their contacts with investors and financial institutions often help them quickly identify people who are interested playing a role in an acquisition. Getting specialists involved at the outset also greatly simplifies tax reporting.

For more information on the above, call/email our Founder & CEO + Business Lawyer, Hugues Boisvert at hboisvert@hazlolaw.com or +1.613.747.2459 x 304

4 ways of custom financing an acquisition

Acquiring a business often requires multiple sources of financing. This can be a complex undertaking, especially in cases when more than $500,000 is needed. In most cases, there are four types of lenders and investors willing to finance an acquisition.

Lenders interested in fixed assetsAcquiring a business often involves the purchase of buildings or equipment. Your tax advisor might suggest you take out a separate bank loan for this part of the project, either from your bank or jointly with other financial institutions.

The Canada Small Business Financing Program makes it easier for small businesses to obtain financing from banks up to a maximum value of $500,000, of which $350,000 can be used to finance the purchase or improvement of equipment and the purchase of leasehold improvements.

Lenders interested in the whole package BDC often supports expansion projects with term financing. Unlike conventional bank loans, this formula allows flexible repayment terms. Another advantage is that a BDC loan will not be called without a valid reason.

Companies that have a competitive advantage in a fast-growing industry should consider subordinate financing. Under this formula, financial institutions lend higher amounts than they would under other circumstances and accept subordinate security in return. But such arrangements will always require a higher return for the lender, who may also ask for royalties on future sales or stock options.

Equity investorsDepending on your situation and the amount you need to raise, you can seek out venture capital from investment banks, institutional investors and mutual or labour-sponsored funds. Your new financier will become a major financial partner, taking an ownership stake in your company and the right to name some members of your board in exchange for a significant injection of capital. Industry Canada's web site has more information on this subject.

Venture capital firms invest across all sectors of the economy but target only businesses with excellent growth potential. Sometimes technology-oriented venture capital companies also consider outright acquisitions. For example, they will look favourably on buying a leading-edge business with products almost ready to put to market that would complement a more mature company's product line.

Strategic investors
These investors focus on certain types of businesses and are often faster than others to grasp developments within a particular industry. These are often groups of professionals from the same industry who keep close tabs on their market and are therefore quicker to recognize risks and opportunities. Major corporations also sometimes acquire equity in companies whose growth they believe it is in their interest to support. The goal can be to exploit a promising niche in their industry, for example, or to improve their firms' technological know-how. Regardless of the type of financing you have in mind, management consulting companies and accounting firms specializing in acquisitions can provide invaluable outside advice. Their contacts with investors and financial institutions often help them quickly identify people who are interested playing a role in an acquisition. Getting specialists involved at the outset also greatly simplifies tax reporting.

A common exit strategy: The MBO ...

If you're an owner looking to sell your business or an employee thinking of buying the company you work for, you should be familiar with the term management buyout (MBO). In its simplest form, an MBO involves the management team pooling resources to acquire all or part of the business they manage. A Leveraged Management Buyout (LMBO) is similar to a MBO, except that the buyers use company assets as collateral to secure financing.

Most of the time, the management team takes full control and ownership, using their expertise to grow the business. An MBO/LMBO acquisition, which can be sizable, is usually funded by a mix of personal investors, external financiers and the seller.

For a business undergoing a change in ownership, the MBO/LMBO offers advantages to all concerned. Most obviously, it allows for a smooth transition. Since the new owners know the company and its business, there is reduced risk, other employees are less likely to be apprehensive and existing clients and business partners are reassured. Furthermore the internal process and transfer of responsibilities remain confidential and are often handled quickly. Once a business owner has agreed to sell his company to members of his staff, there are usually a series of common steps in the transfer of power:

• Buyer and seller agree on a sale price.
• A valuation of the business confirms the agreed-upon price.
• Managers assess the portion of the shares they could purchase immediately, and then draft the shareholder agreement.
• Financial institutions are approached.
• A transition plan is developed that incorporates tax and succession planning.
• Managers buy out the sellers' interest with financial support.
• Decision-making and ownership powers are transferred to the successors; this can take place gradually over a period of a few months or even a few years.
• Managers pay back the financial institution. This is done at a time and pace that will not unduly slow the growth of the business.

Buyers will need to ensure that the venture is profitable or at least has good potential to be. Keep in mind that the MBO/LMBO requires substantial financing, which will have an impact on company cash flow. To compensate for the repayment, the buyer will need a strategy to increase cash flow through cost-cutting, improved productivity or building revenue.

A thorough financial analysis should reveal cash flow, sales volume, debt capacity and potential for growth. This will provide valuable information on the fair market value of the business and on management's operating flexibility.

How to finance an MBO/LMBO
The buyer(s) will need to develop a strong business plan to prepare for the acquisition. The forecast should be credible and realistically attainable. Personal and business contacts and referrals can also help a successor secure confidence from bankers. A small buyout usually involves only one institution. In larger transactions, several institutions may handle the financing.
In an LMBO, business assets are evaluated to determine the equity available for financing. The lender will use the assets as collateral. The financial institution will adjust interest rates according to the risks associated with the transaction.

The financer may ask the seller to finance a portion of the sale as a form of commitment to the venture, and as a sign of confidence in the management team. Be sure to shop around for the best terms.

Any of these types of basic financing may be combined to achieve a successful transition.
Personal funds can help secure confidence from a financial institution, add equity to the transaction and share risk. Buyers often need to invest a significant amount of personal money — which may involve refinancing personal assets — to demonstrate their commitment. Loan or credit notes from banks are often used to purchase owner shares in the business. This type of financing is attractive because of its simplicity—assets are used as collateral—and because interest rates are lower.
Seller/owner financing can extend payments over a number of years. This form of financing is tied directly to the seller and may include credit notes, loans or preferred shares. This may reduce cash outflow at time of transaction and make the transition easier.

Similarly, an installment purchase of stock allows the seller to maintain a level of control until he or she is completely paid off.

Selling stock to employees can be used in conjunction with an MBO/LMBO to finance the remaining portion. The Employee Share Ownership Plan Association explains how this type of financing enables other employees to purchase stock options in the business. This can give incentive to existing employees while the management team retains control of the business.

Subordinate financing can complement a management team's equity investment by bringing together some features of debt financing and equity financing without diluting ownership. If a profitable business maximizes the financing on its assets, and the management team's personal funds are insufficient, then subordinate financing may take on a higher risk to participate in the venture. Repayment terms are established at time of transaction.

For more information: http://www.bdc.ca/EN/advice_centre/sell_your_business/Pages/RelatedArticles.aspx?PATH=/EN/advice_centre/articles/Pages/succession_mbo.aspx