3 tips to create your capital structure when buying a business
When it comes to structuring the financing of an acquisition, no two deal will look the same. Current valuations, which are at the high end of historical averages, have made it harder to create the optimal capital structure, with a mix of term debt, mezzanine financing, equity and vendor financing.
“If you’re a disciplined buyer on price, you’re probably challenged right now to find a company,” says Patrick Latour, Senior Vice President, Growth & Transition Capital with BDC Capital.
“You used to be able to increase value by growing revenues and improving margins, for example by investing in more productive equipment,” he says. “The gains now are going to come from investments you make to the business model, and how you are going to invest in digitization.”
Latour gives the following tips to create a capital structure that allows you to reinvest following an acquisition.
1. Make sure you can implement your plan
Having the seller finance too large a proportion of the acquisition can sometimes complicate the transition process. At other times, vendor financing can be extremely accommodating.
“It’s important to know that, after the financial structure has been put in place, everybody is aligned,” Latour says. “If the new ownership has a plan in place, you don’t want a vendor note to hinder your ability to implement that plan.”
2. Protect your cash flow
A business transfer is almost always followed by a period of turbulence. Only two in five companies met their financial expectations a year after a transition, according to a BDC study of 200 Canadian small and mid-sized businesses.
To ensure you have a maximum of flexibility following a transition, it is a good practice to divide the financing among several financial institutions based on what they offer. For instance, you can balance the strict repayment requirements of term debt with the flexibility of mezzanine to ensure you have the ability to invest in future opportunities.
“You need to match your business plan and your ability to repay with the right mix of debt instruments,” Latour says. “In an environment where valuations are high, you’d think every deal would have a sliver of mezzanine to help with the flexibility.”
3. Consider a minority equity investor
Carefully chosen, a minority investment can be a great solution for entrepreneurs looking to grow over the long term, while remaining in control of their business.
“A minority investment allows the company to share the risk with a partner,” Latour says. “Because acquisitions don’t come without risk.”
He adds that taking on minority investors improves the governance of the company by introducing a formal board and will help define the strategy as well as align your management team.
“That really forces the conversation around the strategy of the business and where are the areas of growth,” he says. “It’s a good alternative to a buyout fund or selling a business. The owner remains in the majority and in control.”