While liquidity of 20 to 30 percent of the price is common, lenders can be flexible and there are options to access any additional financing needed.
When you buy a business, the size of your down payment matters because it impacts your finances for years to come.
While there is no simple formula for calculating the ârightâ size for a down payment, Jade Hipson, senior account manager at Business Development Canada (BDC), says it’s important to show that you have some skin in the game.
âThere are many parties that are invited to take a risk on you – the lenders, the investors, even the buyer,â Hipson said. âThe best way to show your commitment to these parts is to have a large down payment. “
She says a good rule of thumb is that the down payment covers 20-30% of the purchase price. Even so, lenders will often take into account that a seasoned entrepreneur is likely to have different financial means than a newbie, so the percentage may vary.
Overall, lenders are looking for meaningful engagement in one form or another.
Someone who has worked in a business for many years and now wants to buy the business or part of it, for example, will sometimes be able to buy the business with a smaller down payment. In this situation, the buyer could argue that he is less risky than a pure outsider. This could prompt a lender to reduce its shareholder investment requirements.
If lenders do not want to proceed with a new shareholder who does not have significant funds to invest, one solution may be for the buyer to purchase the company over time. In these situations, the seller will slowly sell shares to the buyer and gradually exit the business.
Where does the rest of the money come from?
If you put up to 30 percent of the purchase price, the remaining funds can come from a variety of sources.
A bank loan
Also called âsenior debtâ, this is a common way to cover part of the purchase price. This type of loan usually has a defined repayment schedule and a relatively low interest rate compared to other options. The terms and conditions will depend on various factors including the amount of your down payment, available guarantees and expected business performance.
A low interest rate often comes with tough repayment terms that you can only meet if your business is running well from the start, but since that often doesn’t happen, it’s important to add flexibility.
Also known as ‘junior debt’ or ‘subordinated debt’, this is a more flexible type of loan that can be structured in a number of ways and sometimes even treated as equity, thereby increasing your amount. downpayment.
This type of debt offers repayment conditions adapted to the cash flows of a company and aims for a return on investment that will be more expensive than senior debt but will have flexibility in the way in which this return is achieved (i.e. – say a mix of a lower coupon interest rate plus a variable return, such as a bonus or a portion of the royalties).
Note that mezzanine loans rank below secured debt as a priority for repayment in the event of default.
Also called âsupplier financingâ, this is an attractive option when you want to add flexibility to your financial structure. In this case, the person selling the business takes part of the price up front and agrees to pay the balance at a later date, often after paying off much or all of your senior debt.
This balance is usually secured by a lien on the property and assets of the business. If the buyer defaults on their payment obligations, the seller can withdraw and take over the business, in some cases.
Often, vendor and bank financing are combined. In this case, the privilege of the seller is subordinate to that of the bank.
Another type of seller financing involves conditional payments, such as stock options or additional payments (earn-outs), if specified performance goals are met.
These arrangements help keep the seller tied to the future success of the business, which can be helpful in overcoming the usual surprises that arise during the early years of transition.
– WI staff with the Business Development Bank of Canada.