The impact of the financing package on the sustainability of operations after a business transfer
Since the turn of the millennium, we have experienced the first ever large-scale transfer of businesses in Canadian history. No matter if we are talking about management buyouts, mergers/acquisitions or family successions, we have a lot more experience today than we did 15 years ago.
In our day-to-day work at BDC Capital, we support hundreds of entrepreneurs in the years following business transfer transactions. I would even go as far to say that we coexist with them, because we invest significant amounts of money and share the risk with them. On numerous occasions, we have seen the impact the design of the financing package can have on business operations.
These experiences have taught us a lot about best practices in business transfers, which is something that we can now share.
For example, our experience attests that an appropriate financing package is one of the winning conditions for a successful business transfer. And by success, I don’t just mean closing the deal, but first and foremost, ensuring the business’s sustainability in the years following the transfer. Because, afterwards, you have to be able to live with the financing!
Here are a few things to consider when establishing a financing package that can stand the test of time.
Plan for the inevitable and for unforeseen turbulence
- Come from within the business—arrival of new managers, impact on employee motivation, changes in processes
- Come from outside the business—loss of customers, changes at the suppliers, competitor opportunism
Not to mention that, transaction or not, entrepreneurs live in constantly changing environments! In the majority of these transactions, business owners put the business into debt using leverage, a tool that must be used with caution.
Learning to know one’s partners
Let’s start with a qualitative element. Financing such a major transaction is not easy. To make the right choice, you have to get to know your partners. This goes for financial institutions, but even more so for strategic partners.
- What is their vision, exit horizon and objective in this transaction?
- What is their reputation for dealing with turbulence?
- How much experience does your counterpart have in the specific type of transaction that you are planning?
- Is the financial partner making you an excellent offer but stepping outside of his or her comfort zone and won’t be able to follow through?
A good practice is to divide the financing among several financial institutions by taking the best of each one. The small investment of time that you dedicate to securing the relationship with the partners will increase your chances of being successful in the years following the transaction.
Increased complexity requires greater flexibility
A second concept is that, generally, the more variables there are that are likely to change, the more leeway must be provided by the financing package. Let’s examine the case of two businesses:
- Steady revenues: Sells consumer goods, no seasonal fluctuation.
- Diverse customer base: A variety of clients in several mature industries.
- Internal purchaser: Purchased by the CEO who already operates it.
- Variable revenues: Manufactures large equipment that sells when clients invest in their capital assets. Contracts are often signed in the spring.
- Specialized: Some big clients in industries subject to fluctuating commodity prices.
- External purchaser: Purchased by third parties, new managers to be hired.
If both businesses generate, on average, the same profitability, business A can afford greater leverage than business B.
- Business A can rely on recurring cash inflows to cover its fixed-date, recurring debt payments.
- Therefore, business A can use a large portion of its anticipated available funds to repay its debt because its cash inflows are more predictable.
Business B will surely have unpredictable cash inflows and must expect significant variations from one month, quarter or year to the next.
- Business B’s financing package must include more shareholders’ equity.
- Company B must use debt instruments that will provide it with flexible repayments, longer maturities or repayments conditional on performance (to align required cash outflows with cash inflows from operations).
Maintain a liquidity margin after the transaction
A third factor that we often forget, even though it seems obvious, is that few people buy businesses to leave them as is! A business that does not evolve will quickly lose its relevance.
The purchasers’ projects require investment before they can generate profit. The more ambitious the plan, the more the repayment obligations must be limited, and the more liquidity the business must maintain after the transaction.
It is always unfortunate to see a business that just changed hands have to miss its turn when a good opportunity presents itself because it took on financial obligations from its transfer transaction too quickly.
Use your additional liquidity to your advantage
Finally, I would add that businesses that maintain financial flexibility after a transfer transaction can use this asset to their advantage. And this can go well beyond reducing the cost of financing.
I am thinking here about additional power during negotiations with a supplier or client who does not pay on time, or simply the opportunity to hire the right resource when it is available, without having to wait for the funds.
More than anything else, conserving your liquidities will allow you to focus your energy on managing the business rather than its cash flow.
In conclusion, having the right partners and the means to stay focused while your competitors are experiencing turbulent times could be a lucrative opportunity and put you on the path to long-term sustainability!