General information only. This article is educational and is not financial, legal, tax or investment advice, or an offer to lend or invest. Get advice from qualified professionals about your situation.
Many Alberta business owners are thinking about succession, and many operators and first-time buyers want to buy an established business rather than start from scratch. Few buyers pay cash. Most deals are funded by a combination of sources, often called the capital stack. Here is how the pieces usually fit together.
1. Senior debt
Senior debt is the first-ranking loan, usually from a bank, credit union or a government-backed lender such as BDC. It typically has the lowest cost and the strictest requirements: historical cash flow, security over business assets and often personal guarantees. Lenders will look closely at whether the business's cash flow can comfortably cover the loan payments.
2. Vendor take-back (VTB)
In a vendor take-back, the seller agrees to receive part of the purchase price later, effectively lending it to the buyer. A VTB shows that the seller believes in the business after they leave, which can make other lenders more comfortable. Terms such as interest, repayment schedule and whether it is subordinated to the bank are negotiated.
3. Mezzanine or subordinated debt
When senior debt and the VTB do not cover enough of the price, mezzanine debt can fill the gap. It ranks behind the senior lender, so it costs more and may include an equity-linked feature. It lets the buyer keep more ownership than raising extra equity would.
4. Equity
Equity is the buyer's own money plus any money from partners or investors who take an ownership stake. Lenders almost always expect the buyer to put real money in. A partner can contribute equity in exchange for a share of ownership and returns, as a joint venture or co-investor.
An illustrative example
The following is a made-up example to show the structure, not a quote or a typical deal. A buyer agrees to purchase a business for $2,000,000. The stack might combine a senior loan, a seller VTB, a smaller mezzanine piece and the buyer's equity, each with its own terms and ranking. The right mix depends on the business's cash flow, the assets, the seller's flexibility and the buyer's resources.
What makes an acquisition financeable
- Several years of stable, documented earnings.
- A purchase price that makes sense relative to those earnings.
- A transition plan so customers, suppliers and staff stay after the owner leaves.
- A buyer with relevant experience, or a strong management team staying on.
- Clear due diligence: financial statements, tax filings, contracts, leases and any liabilities.
Common pitfalls
- Taking on so much debt that the business cannot handle a slow year.
- Relying on "add-backs" to earnings that a lender will not accept.
- Skipping a quality-of-earnings review or legal due diligence.
- Not agreeing how the seller will transfer relationships.
Buying or selling a business in Alberta or elsewhere in Canada? Read more about acquisition financing or submit your deal for review.
Related
Acquisition Financing · Mezzanine & Subordinated Debt · Joint-Venture Equity