Is 2023 a good year to buy a company in Canada?
Is it still a good time to buy a company in Canada? If you are thinking about buying a business, economic headwinds and rising interest rates may be making you think twice.
You have to consider the impact of higher loan costs and how they affect the financial sustainability of completing an acquisition. Heightened uncertainty can also make it harder to forecast how the target business will perform.
That said, the mergers and acquisition (M&A) market is still seeing a healthy volume of transactions. This is partly due to older entrepreneurs looking for a retirement exit. Some buyers are also being enticed by the prospect of finding good deals at lower valuations.
What can you expect in today’s market if you are thinking about buying a business, and how can you protect yourself from uncertainty? Read on.
The corporate M&A market has declined, but the smaller transition market remains vigorous
After recovering from the pandemic slump, Canada’s M&A market saw record activity in 2021 with $374.5 billon in announced, completed or pending deals, according to a report by Bennett Jones. The volume in 2022 declined nearly 25% to $287 billion.
But those numbers don’t tell the whole story. While overall deal activity has taken a hit in today’s uncertain times, we continue to see a lot of deal-making in the smaller transition market.
This is largely driven by two factors. First, Canadian entrepreneurs—like the rest of the population—are getting older. In fact, 59% are aged 50 and up—versus only 32% of the Canadian workforce, a BDC study reported in 2021. One in six are 65 or older.
As a result, nearly 10% of small and mid-sized businesses in Canada were expected to be for sale externally (i.e. to buyers other than family or management) in the next five years, according to the BDC study. This represents 116,000 companies.
A second likely factor is market expectations of lower business valuations. Prices face downward pressure because of higher interest rates and uncertainty over future rate increases. Financing a purchase is more expensive, and buyers may also be feeling cash flow constraints in their existing business.
Lower valuations could allow you to discover solid companies available at attractive prices.
Is it still a good time to buy a business?
It can still be a great time to acquire a company despite the higher rates. The most important factor justifying an acquisition remains the same today as it always has been: Does the acquisition meet your goals?
- increasing your market share
- improving your profit margin
- acquiring new technology
Being clear on your goals will help you find the right business to acquire at an appropriate price level.
Good reasons to buy a business in 2023
Plenty of supply
While today’s market may bring more uncertainty, this may also be offset by the once-in-a-generation wave of businesses coming on the market from retiring entrepreneurs. That means it’s probably a buyer’s market.
More attractive prices
With greater financial uncertainty, you may be able to find the right company to acquire. When interest rates were lower, sellers enjoyed rising valuations and may have been less flexible on the price or deal structure. Not so much today.
It’s hard to time the market
If you hold off on an acquisition because you expect rates will eventually move lower, you may be in for a long wait and you may miss opportunities to achieve your business goals.
Besides, as most investors know, it’s notoriously hard to time the market. Even the experts have lots of trouble doing that.
What can buyers expect in the current climate?
Despite the economic ups and downs, buyers may still see some price stickiness on the part of sellers. Vendors could be thinking in terms of last year’s prices, and some haven’t yet adjusted to the expectations of today’s buyers and the current market realities.
Another sticking point can be financing. The buyer and seller may agree on a certain multiple, but a lender may have a lower valuation in mind and be unwilling to finance the full amount the buyer needs.
How can the buyer, seller and lender come together when they have different price expectations? The answer is creative deal and financing structures. These levers can make all sides happy and improve the chances of a successful acquisition.
Creative deal structures
An earn-out can be used to bridge the gap between the buyer’s and seller’s perceptions of a company’s value or future earnings. This is an arrangement in which some of the purchase price is payable only after the closing and is earned only if and when certain conditions are met.
The conditions are usually related to the company’s financial performance, such as attaining a certain profit or sales level.
An earn-out provides a way for the seller to get their desired valuation, while the buyer mitigates their risk that the company may not perform as expected after the transaction. The buyer also benefits from the fact that the seller is more motivated to ensure a successful transition.
As an example, take a company with $1 million in EBITDA. The buyer and vendor both agree on a transaction price of four times EBITDA, or $4 million. But they don’t agree on future earnings. The buyer is concerned that EBITDA after the transaction could fall to $800,000, while the vendor insists earnings will remain at $1 million.
The two sides could resolve the discrepancy with an earn-out. The buyer agrees to pay $3.2 million up front and an additional $800,000 after the first year if the business achieves $1 million in EBITDA.
Example of an acquisition using an earn-out
|Transaction price||$4 million|
|Upfront payment||$3.2 million|
|Target EBITDA for earn-out||$1 million|
|Earn-out period||First year after the transaction|
Vendor financing (also known as vendor take-back or a vendor note) is another way buyers and vendors can find common ground. This is a loan that the vendor gives the buyer to help finance the acquisition.
A vendor note differs from an earn-out because the former is repaid over a set period regardless of the company’s future performance.
Vendor financing is commonly used if the buyer isn’t able to raise the entire purchase price through other methods, such as a bank loan and their own money.
Returning to our example above, the buyer might agree to pay the full $4 million for the company, but may be only able to raise $3 million from the bank and their own funds. To complete the purchase, they can ask for a $1-million vendor note (repayable, for example, over five years).
Example of an acquisition using vendor financing
|Upfront payment||$3 million|
|Vendor note||$1 million|
|Repayment period||5 years|
How can buyers protect themselves from uncertainty?
Uncertainty is a given when acquiring a business. To be prudent, assume your first year won’t go to plan. The solution isn’t necessarily to plan for the worst. It’s to plan for things not going according to plan.
You can address the uncertainty by envisaging different scenarios for the acquisition and forecasting out the financial impacts in your projections. Imagine what could go wrong, and think about how you’d mitigate that.
Here are other solutions.
Keep the vendor involved
A vendor motivated to help your business succeed can smooth the transition for key employees, customers and suppliers and keep them all on board. You can maintain the vendor’s involvement with an earn-out, vendor note or a role in the company post-transaction, such as hiring them as a consultant or executive.
Get good financial advice
Be sure you have a knowledgeable financial expert on your team. If you don’t have financial expertise on your team, take steps to fill that role. Solid financial advice is essential for good business decisions.
This is especially the case when undertaking a major project such as a business acquisition when it’s critical to have adequate forecasts and reporting in order to keep on top of issues, stay in covenant and have confidence in your line of sight to potential surprises.
It’s important to have a financial buffer in case of surprises or underperformance during the transition. When assembling your financing package, look beyond the interest rate and consider the terms and conditions of your loans.
Flexible repayment terms can allow you to keep more cash in your business during the transition period, allowing you to weather hiccups more easily. Such terms could include:
- a customized repayment schedule tailored to your cash inflows
- an initial interest-only period
- a balloon payment in which you pay interest during the loan term (and possibly some of the principal), then repay all of the principal (or the remaining balance) when the loan is due
Where can you get advice about making an acquisition?
Motivated buyers and sellers are turning to creative deals and loans more often in today’s higher interest-rate environment. These can keep the vendor happy, while also addressing the concerns of buyers and lenders about how to service acquisition debt in an uncertain market.
But such solutions can be complex and require expert advice. A lawyer with experience in acquisitions and your banker can advise you on your options and how to structure a transaction to help ensure it’s successful.
I invite you to reach out to our team of financial experts who work with businesses across the country to find transition solutions that work for them.