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Financing the purchase of a business

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A purchaser of a business needs to have financing in place during the search process, so that opportunities that arise can be promptly acted upon. The creditworthiness of the purchaser will be important in determining the type and extent of financing that can be arranged. If the purchaser is an existing company that already has a proven successful business in place, then arranging the financing for the new acquisition will likely be easier than the case where the purchaser is an individual going into business for the first time.

One possible type of financing is bank line of credit. If the purchaser already has an existing line of credit, then perhaps arrangements can be made with the bank to expand this to include the funds required to purchase the new business. Alternatively, the bank could set up a specific loan for the acquisition which would be paid back over a fixed period of time. Since banks normally require specific assets to be held as security for the loan, the bank will likely be involved in the valuation of the assets of the new business. Furthermore, the type of business being purchased will be of great interest to the bank since they would not feel comfortable financing the acquisition of a type of business in which they have little experience or in which they have had poor loan performance in the past. The bank would also be very interested in seeing the cash flow projections for the new business, and in analyzing the numbers to ensure they are credible. The bank will also want to determine whether the purchaser has a qualified management team in place with good experience in the type of business being acquired.

“Vendor take-back” is a general term to describe an arrangement whereby the vendor is involved in the financing by agreeing to be paid part of the purchase price over an extended time period. There are many possible variations for handling this, including earn-outs, which means that the actual amount paid for the acquisition is dependant on the future performance of the acquired company. Future performance can be measured in many ways, including sales, gross profit, net profit and customer retention. The agreement of purchase and sale will detail the exact methodology to be used to calculate the earn-out, which should fit with the purchaser’s overall goals that were drawn up for buying the company.

When approaching a prospective lender, it is essential to have a well-prepared financing proposal in place, which will give confidence to both the purchaser and the lender that the acquisition has been carefully thought through and warrants serious consideration. The financing proposal or business plan includes both quantitative and qualitative information about the company to be acquired and the management team. Important information to include is the amount of loan requested, the purpose of the loan, requested term of the loan, repayment terms, physical security available and the extent of the purchaser’s financial commitment. The bank is always interested to see that the borrower is willing and able to be personally involved in the financing as opposed to expecting the lender to shoulder the entire burden. Quantitative information should include audited financial statements of both the borrower and the company to be acquired for the past 3 to 5 years, the latest unaudited interim financial statements of the target company, identification of expenses and revenues that are non-recurring or irrelevant to the future profitability of the acquired company, forecasted income statements for the next three years with commentary as to how the numbers were calculated (prepared on a sensitivity analysis basis to indicate a range of possibilities), monthly cash flow forecast for the first year of operation of the acquired company, projected capital expenditures for the next 3 years with commentary as to how these expenditures will produce returns for the company, aged accounts receivable and payables, and description of inventories and fixed assets. Qualitative information for the business plan should include a detailed description of both the purchaser’s and the target company’s history, details of the new company’s ownership structure after the completion of the transaction, a discussion of the key factors that have contributed to the acquired company’s financial results over the past 3 to 5 years, sales and marketing plans, description of physical facilities, labour and production process, industry analysis, and personal resumes of the new management team. Please contact Simkover and Associates at 905-943-4046 if you need further advice in relation to this topic.

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