Business & Acquisition Financing
How to Finance a Business Acquisition in Canada
Buying an established business often requires more than a conventional commercial loan. The financing structure may combine buyer equity, senior debt, vendor financing and other forms of capital. Understanding how lenders evaluate an acquisition can help buyers structure a more financeable transaction.
Contents
- How Business Acquisition Financing Works
- What Do Acquisition Lenders Evaluate?
- Building the Acquisition Capital Stack
- How Much Equity Does a Buyer Need?
- The Role of Vendor Financing
- Acquisition Financing and Valuation Are Connected
- Financing Should Begin Before the Transaction Is Finalized
- Information Buyers Should Prepare
- How CFM Approaches Business Acquisition Financing
Buying an established business can be an effective way to enter entrepreneurship, expand an existing company or acquire new customers, capabilities and markets.
But agreeing on a purchase price is only part of the transaction.
The buyer must also determine how the acquisition will be financed and whether the acquired business can reasonably support the proposed capital structure.
Unlike financing a specific asset, acquisition financing requires lenders and other capital providers to evaluate the business, buyer and transaction together.
This makes acquisition financing both a credit decision and a transaction-structuring exercise.
How Business Acquisition Financing Works
A lender considering a business acquisition wants to understand not only what is being purchased, but also how the acquisition debt will ultimately be repaid.
In many transactions, repayment depends substantially on the future cash flow of the acquired business.
The lender therefore needs to assess the historical financial performance of the company, the sustainability of its earnings, the buyer's capabilities and financial resources, the purchase price and the overall transaction structure.
The resulting financing package may involve several sources of capital rather than a single loan.
What Do Acquisition Lenders Evaluate?
Acquisition lenders weigh the company, the buyer and the terms of the deal together rather than in isolation.
Historical Financial Performance
Lenders will generally examine the company's historical revenue, profitability and cash flow.
They may also consider trends in margins, working capital, customer concentration, recurring revenue and other factors affecting the sustainability of earnings.
Financial results may need to be normalized where there are legitimate non-recurring expenses or owner-related items, but adjustments should be credible and supportable.
Debt-Service Capacity
One of the central questions is whether the acquired business can generate sufficient cash flow to support the proposed acquisition debt while continuing to fund normal operations.
A business may be profitable but still have limited capacity for acquisition debt because of working-capital requirements, capital expenditures, existing obligations or volatility in cash flow.
The Buyer
The buyer matters.
Relevant considerations can include:
- industry and management experience
- financial resources
- creditworthiness
- ownership structure
- amount of equity being invested
- ability to manage the acquired company
- experience operating or acquiring businesses
A strong management plan can be particularly important when the existing owner plays a significant role in day-to-day operations.
The Business Being Acquired
Lenders may consider the company's:
- industry
- competitive position
- customer base
- supplier relationships
- recurring revenue
- assets
- management team
- dependence on key individuals
- growth prospects
- overall business risk
A lender is ultimately assessing the durability of the cash flow expected to repay the acquisition financing.
Transaction Structure
The terms of the acquisition itself can materially affect financing.
The purchase price, asset-versus-share structure, working-capital arrangements, vendor financing, earn-outs and other transaction terms can influence both the amount of capital required and the risk assumed by lenders.
Acquisition financing is both a credit decision and a transaction-structuring exercise.
Building the Acquisition Capital Stack
Many acquisitions are financed using a combination of capital sources.
Buyer Equity
The buyer will typically contribute capital to the transaction.
The required amount depends on the business, transaction, lender, cash flow, available security and other sources of capital.
Senior Debt
Banks, credit unions and other commercial lenders may provide senior acquisition financing where the business and transaction meet their underwriting requirements.
Senior debt will generally have priority over more junior forms of capital.
Vendor Financing
The seller may agree to finance a portion of the purchase price.
Vendor financing can reduce the amount of third-party capital required and may help bridge financing or valuation gaps.
It can also demonstrate that the seller retains confidence in the business following the transaction.
The terms of vendor financing remain important because senior lenders will consider how that obligation interacts with their own financing.
Subordinated Debt and Private Credit
Where senior financing does not provide sufficient capital, buyers may consider subordinated debt, private credit or other structured financing.
These sources can provide additional flexibility but may carry higher costs or different structural requirements.
Equity Capital
Some acquisitions require additional equity beyond the buyer's own capital.
Outside investors, strategic partners, family offices or other equity providers may participate where appropriate to the transaction.
The resulting ownership implications should be considered alongside the financing requirement.
How Much Equity Does a Buyer Need?
There is no universal equity requirement for acquiring a business.
The amount depends on factors including the quality and stability of the business's cash flow, available assets and security, purchase price, industry, buyer profile, lender requirements and the structure of the transaction.
A transaction with substantial recurring cash flow, strong tangible assets and an experienced buyer may be financed differently from a company with volatile earnings, limited assets or significant customer concentration.
The objective should not necessarily be to maximize leverage.
The objective is to create a capital structure that allows the acquisition to close while leaving the business with a reasonable ability to operate, invest and service its obligations after closing.
The Role of Vendor Financing
Vendor financing can be particularly useful in business acquisitions.
It may:
- reduce the immediate cash requirement
- reduce the amount of third-party financing required
- help bridge a valuation or financing gap
- align buyer and seller interests during a transition period
- demonstrate continued seller confidence in the business
However, vendor financing is not free capital.
Its repayment terms, interest rate, security, subordination and relationship with senior lenders all form part of the overall capital structure.
Acquisition Financing and Valuation Are Connected
A buyer may value a business based partly on expected future opportunities.
A lender, however, will generally place substantial weight on demonstrated financial performance, repayment capacity and transaction risk.
This creates an important distinction.
A transaction can make strategic sense to the buyer and still be difficult to finance at the proposed purchase price.
The relationship between valuation and financing should therefore be considered before the buyer becomes irrevocably committed to a transaction.
Financing Should Begin Before the Transaction Is Finalized
Waiting until a definitive purchase agreement is nearly complete before considering financing can create unnecessary transaction risk.
Earlier financing analysis may help identify:
- realistic leverage
- required buyer equity
- potential lender concerns
- working-capital requirements
- the need for vendor financing
- alternative capital sources
- appropriate financing conditions
- realistic closing timelines
Understanding these issues earlier can also influence negotiations with the seller.
Where possible, the acquisition strategy and financing strategy should develop together.
Information Buyers Should Prepare
The exact requirements depend on the transaction, but acquisition financing will commonly require information such as:
- three years of historical financial statements
- current interim financial information
- purchase price and proposed transaction structure
- letter of intent or purchase agreement where available
- description of the target business
- buyer background and management experience
- proposed ownership structure
- source and amount of buyer equity
- details of existing and proposed debt
- financial projections where relevant
- proposed vendor financing or earn-outs
- information regarding significant assets, customers and contracts
A coherent financing package helps capital providers understand both the business and the transaction.
How CFM Approaches Business Acquisition Financing
CFM approaches acquisition financing by first understanding the business, transaction and buyer's objectives.
From there, the financing requirement can be evaluated in the context of the purchase price, cash flow, buyer equity, transaction structure and available capital sources.
Depending on the circumstances, the resulting capital structure may include senior debt, vendor financing, private credit, subordinated capital, equity or a combination of sources.
CFM's broader work in M&A and transaction advisory also allows the acquisition and its financing requirements to be considered together rather than as separate exercises.
Sebastien Charles is the Founder and Managing Director of CFM Financial Consulting Inc. His experience spans entrepreneurship, corporate finance, M&A, capital raising, commercial financing, executive leadership and governance.
This article is provided for general informational purposes only. Financing availability, terms and underwriting requirements vary by lender, transaction and borrower circumstances. The information should not be considered financial, legal, tax or investment advice.
Related Capabilities
Related Insights
M&A & Transaction Advisory
Selling a Business in Canada: What Owners Should Consider Before Going to Market
Preparing a company for sale should begin well before approaching potential buyers. Financial reporting, management dependence, customer concentration and transaction structure can all influence value and deal certainty.
Capital Raising
Raising Capital for a Business in Canada: Debt, Equity and the Capital Structure
Choosing between debt and equity can affect ownership, cash flow, risk and the future flexibility of a business. We look at the considerations that should drive the capital decision.