How to Finance the Business You Want to Buy

You may have made it past all the other checkpoints, but if you’re unable to secure financing for the business you want to buy, your journey ends there. 

In my article, How to Choose One Business Over Another, we looked at 12 areas of consideration in determining what makes one business more valuable than another: location, assets, products or services, inventory, trained employees, existing customer base, established suppliers, competition, the industry, existing cash flow, financial records, and systems and procedures.  

Let’s pick up where we left off.

What you are going to do with the business after the purchase has a direct relationship to your perceived value of the business. If you can develop a realistic plan of action to improve the business after your acquisition your likelihood of success improves considerably.

However, none of that matters if you can’t get the financing you need to buy the business in the first place.

The truth about bank loans

It is a common misconception that banks will provide loans for small business acquisitions. In fact, they do not.

If an acquisition is structured as an asset purchase it may be possible to obtain a loan under the Canada Small Business Financing Program (CSBFP) under which banks can provide financing up to a percentage of the appraised value of furniture, fixtures, and equipment (FF and E). The percentage of financing available varies from 75% to 90% of the value of the FF and E, depending on the bank.

The downside is that the seller is unable to take advantage of the $866,912 capital-gain lifetime exemption, and the allocation of purchase price to market value of furniture, fixtures and equipment triggers a recapture of depreciation and a capital gain. This is unattractive to sellers and will result in a higher purchase price.

Business Development Canada (BDC) is another source of acquisition financing. However, they typically base the financing on the reported cash flow and do not finance restaurants or retail businesses. Their interest rates are high, and they typically insist that the seller financing be subordinate to theirs and remain unpaid until their loan has been retired. This is unacceptable to most sellers.

 The result is that neither program works very well.

Look to seller-provided financing

When the seller is willing to finance a significant portion of the sale, both parties win. The buyer has more confidence in the information provided and in the business, knowing that the seller has sufficient confidence to lend them money for the purchase.

The interest rates charged by sellers are generally lower than elsewhere and in today’s market range from 5% to 7%.

The seller’s note typically has a right of offset protecting the purchaser against fraud and misrepresentation. It also protects the purchaser against claims related to operation of the business prior to their acquisition.

Seller-provided financing typically ranges from 20% to 50% of the purchase price. This enables a share sale resulting in lower taxes for the seller, and the financing may increase what a purchaser is willing to pay. The purchaser realizes lower risk, better terms and a greater commitment of the seller to ensure the purchaser’s success.

Personally, I would not buy any business if the seller was not prepared to finance at least 20% of the purchase price.

Earn-outs, another form of seller financing, base a portion of the valuation on actual future performance. They can be used to bridge the gap between a buyer’s perception of the future and risk and the seller’s perception of the same. While they reduce a purchaser’s risk and provide incentive for the seller to make sure the purchaser has success, earn-outs may in fact increase the cost of the business should it prove very successful.

The availability of seller-provided financing and the considerations described in How to Choose One Business Over Another are all factors in the value of any given business on the market.

But in the end, your choice of business should come down to one final, individual factor—whether or not you can see yourself in the business.

A common trait amongst successful business owners is a passion either for what the business does (i.e. the provision of the product or service) or a passion for building and operating a successful business. You as the purchaser must have a passion for one of these. If such passion does not exist, it’s time to look at another opportunity keeping in mind that “there is no perfect business”.

Learn what you can from observation, from the documentation your business broker provides, from meetings and discussion with the business owner and from your industry and market research. In the end, you will make the choice. You will never have all of the information you would like to have in order to make an informed choice, but you can still conclude that - all things considered - “this business might work for me.”