Buying a business: How to prepare for the unexpected
Read time: 4 minutes
With so many baby boomer entrepreneurs heading for retirement, it’s a great time to be in the market for a business. But if you want to buy a business, it’s crucial to be well prepared and take the right steps.
For example, one of the most commonly overlooked factors in buying a business is the amount of time it can take to finalize the transaction.
“These deals take longer than you expect to put together,” says Matt Price, Managing Director of Growth and Transition Capital at the Business Development Bank of Canada (BDC). “Usually a home is the biggest purchase of your life, but for many entrepreneurs, a business is the biggest purchase. It could take a year or longer from when you start discussions to closing the transaction.”
Buyers also may not be prepared for what Price calls the “soft” issues. These include how well the culture of the company you’re acquiring will fit with your approach and how long the seller will stay on and what role he or she will play.
Buyers avoid tough conversations
“Buyers tend to avoid these difficult discussions, but that’s the worst thing you can do. Be candid about how the buyer and seller’s relationship is going to work during the transition and afterward.”
Financing the acquisition is, obviously, another key factor in a transition. A change of ownership often leads to an increase in a company’s debt and a corresponding decrease in profitability due to interest payments and other expenses.
This can lead to a period of tight finances after the transaction and even a liquidity crisis.
“The majority of businesses don’t hit their financial forecasts in the first year,” Price says. “You want a flexible financing structure so if you do hit bumps, you’re going to be fine.”
A financing package will typically include your contribution as the buyer, a loan from a financial institution secured on the assets of the company and financing provided by the seller, often referred to as vendor financing.
Aim for flexible financing
Many entrepreneurs also use mezzanine financing to round out the package. Mezzanine financing is a hybrid of debt and equity that isn’t secured by specific company assets but instead is based on historic and expected cash flows of the company.
One of the strengths of mezzanine financing is flexible repayment terms that can help ensure your business has enough cash on hand during the often challenging initial period after the purchase.
“The financing mix can really affect your rate of return on the acquisition and how much risk you are taking on,” Price notes.
Due diligence and careful thinking helped chartered accountant Barry Wood with his acquisition of Ontario Excavac, an excavation and utility service company. He looked at more than 60 businesses before making his purchase.
Consider all your options
He says it’s just as important to consider your options when it comes to financing the deal.
“Do you have contacts for debt financing?” Wood asks. “In contemplating buying, will you be able to provide all the equity financing yourself or will you need partners? Who might those partners be? Will their objectives match yours from business plans to exit strategy and timing?”
Wood adds it’s important to think about your long-term plans for your business.
“What will be your own exit strategy? What is the expected time frame for holding the company? This will have impacts on your business strategy and investment decisions.”
Buyers need to go beyond financial statements to ask such questions as: Why is the owner selling? How diversified is its customer base? Is the industry or geographic region heading for difficulty?
Look at several different companies and get to know them. With so many baby boomers heading for the exits, it’s a buyer’s market or will be in the next few years.
Watch out for clashing cultures between your existing business and the one you’re buying. Culture dissonance can sink your acquisition.
Price it right
Look at what businesses are selling for in your industry and region and hold out for a fair price—it’s a critical factor in how profitable your purchase turns out to be.