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Exit Planning: Financing options for business ownership transition

Ian MacFadden
Ian MacFadden - Contributed

By Ian MacFadden

Whether you’re buying or selling a business it’s a good idea to be familiar with the various forms of financing available to facilitate the transition of ownership.

Whether the business is being sold to a third party, to employees or management, or being transferred to a family member, it is likely there will be a need for some form of financing to cover some of the purchase price.

Rarely are buyers eager to use their cash equity, should they have it, to pay the full purchase price. If you are buying a business, there are a number of options available. The right one for you will depend on various factors.

VENDOR TAKE BACK

One of the more common financing mechanisms in the sale of a business is the “VTB” (Vendor Take Back). The owner accepts part of the purchase price in the form of a loan to the business, which is repaid over time from future profits. This can make the business more saleable for a couple of reasons.

First, a VTB can close the financing gap when a buyer simply doesn’t have all the funds required to satisfy the purchase price.

Second, by accepting a VTB, the owner is demonstrating to potential purchasers they have confidence in the business and an investment in its ongoing success. Vendors can protect their interests by holding a mortgage over the assets of the business until the loan is repaid.

TRADITIONAL TERM LOAN

If the company you are purchasing has fixed assets such as buildings and equipment it may be possible to use those assets as collateral for a traditional term loan. The proceeds of the loan can be put towards the purchase price. The amount of loan, interest rate and repayment terms will depend largely on the value of the assets as collateral and the ability of the business to repay the loan through its cash flow.

On the flip side, note that if you are the owner intending to sell the business, it will be to your benefit to properly maintain the properties and equipment. Not only is this essential to the profitable operation of the business, but it could help a potential buyer raise the financing needed to buy you out.

RAISE EQUITY TO FINANCE

Sometimes it is necessary or even desirable to raise equity to finance the purchase of a business. This would require the purchaser to sell shares in the business to another party that is willing to invest, thereby diluting their own shareholdings.

Venture capitalists and private investment “Angels” are always on the lookout for solid businesses having excellent growth prospects. They can bring not only much needed money to the transaction, but valuable business experience, expertise and connections.

The downside is they will often require a major ownership position, if not outright control with 51 per cent of the shares. So the buyer has to decide if the prospects for high growth and big returns is worth losing control to investors that may have a different view of the business and its future.

MEZZANINE FINANCING

Finally, there is a unique financing vehicle called subordinated debt, more commonly known as “Mezzanine Financing.”

It has many of the features of traditional debt but, like equity, is subordinated to all other lenders and can be treated as equity on the balance sheet. This can help to get easier access to more traditional debt.

This form of financing comes with a higher interest rate because of the higher risk to the lender, but has the benefit of very flexible conditions, including repayment terms customized to the businesses’ cash flow. Also, unlike equity, Mezzanine Financing can be structured to leave the owner in full control of their business.

Much has been said and written about the lack of capital available for small businesses. It’s been my experience, however, that if the fundamentals of the underlying deal are sound and there are growth opportunities for the business, lenders and investors will be prepared to take a serious look at supporting the transaction.

Ian MacFadden is co-founder and Partner of exitRITE Planning Services. His column appears the first Thursday of each month. You can reach Ian at ian@exitrite.com or go to www.exitrite.com

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