You’re on the verge of buying an SME as part of a business transfer and negotiations are coming along well. Before your dream can come true, you’ve probably got one more step: convince the bank to help finance the transaction.

Remember that, first and foremost, when financing a project, the lender’s priority is to minimize its risk, particularly considering that an ownership transfer is a fairly risky event in a business’s life.

That being said, as a transferee (we’re using the singular here, even though you may be several partners), you have an advantage over someone who’s just starting a business. The company you want to buy already has a history, its revenues and profitability, clients, etc. are known quantities. You have tangible information to support your application.

Different criteria

The company’s background is a key element in analyzing a business financing project because different criteria apply depending on how old the company is. SMEs that are less than five years old are generally considered to be more sensitive, as they are riskier.

Lenders also consider the size of the transaction, which will impact their requirements. In the case of smaller transactions (under $500,000), for example, the lender will look at a few key indicators, such as the transferee’s credit and net worth and could require personal guarantees. In this type of transaction, the lender could also analyze the transferee’s ability to inject funds to support the business and cover any contingencies.

A solid team is key

If the lender is satisfied with the financial aspects of the application, he will then undertake a qualitative evaluation. This is when he will take a close look at the quality of the transferee’s management team, including:

-The transferee’s entrepreneurial experience and knowledge of the targeted company. If the transferee is already in the company (family member or employee), the risk is lower, since the transferee already knows the business and its industry;

  • Whether key employees are identified and if they will remain;
  • The transferor’s commitment to stay on to ensure a smooth transition;
  • The presence of an advisory committee, ideally with the transferor on board;
  • Whether the transferee is supported by a professional accountant and is receiving outside help (specialists, mentor, etc.), particularly if he has any managerial weaknesses.
Raymond Chabot Grant Thornton - image

Make a good impression

The fewer unknowns in the project, the greater the financial institution’s confidence will be. Be prepared and properly supported. You need to carefully plan the business’s transfer and development.

The financial forecasts must be well developed and based on solid assumptions.

Beyond the numbers though, it’s critical that you make a good impression with the lender. You have to prove that you’ve asked yourself the right questions and found solutions to offset any weaknesses. For example, talk about the support you have (transferor’s involvement, advisory committee, support from a professional accountant, etc.), especially if you’re an external transferee and don’t know as much about how the business operates or its industry.

Our team can help you with complex steps, such as evaluating the business, performing the pre-purchase investigation and determining the strategic issues and business plan.

Hint: To accelerate the processing of your financing application, get the lender involved early on, that way the process won’t be delayed if he has additional questions.

The balance of sale

Another key component of the business transfer financing process is the balance of sale. This is the total transaction amount that will have to be subsequently repaid to the transferor, in accordance with the terms set at the time of the sale.

This is often a major issue during the transfer negotiations. The transferor wants to minimize the balance to reduce risks, the transferee wants a higher balance to keep short-term financing requirements as low as possible.

Most of the time, the lender’s preference is that the transaction include a balance of sale in order to limit its fund injection and share the risk evenly between the three parties: lender, transferor and transferee. The balance of sale takes on greater importance with a less-experienced transferee with limited financing. Furthermore, if there is a balance of sale, it’s in the transferor’s interest to stay on board and support the business’s operations, which also reduces the lender’s risk.

The balance of sale is calculated using the debt ratio, and in a business transfer should not be greater than 3:1, i.e., debt should not be more than shareholders’ equity times 3.

In some cases, the balance of sale could be considered as shareholders’ equity if paying the bank loan has priority. Consider a $400,000 transaction with a $250,000 loan, a $50,000 injection from the transferee and a $100,000 balance of sale. The balance can’t be paid until the loan has been repaid, which reduces the lender’s risk. The balance of sale improves the overall financing application and makes it easier for transferees with limited resources to become shareholders.

If you’re planning to transfer your business, our experts can help. Contact them today!

Next article

Intended especially for foreign companies considering investing in Québec, Taxation in Québec: Favourable Measures to Foster Investment provides an overview of the principal tax measures that apply to companies operating in Québec.

In addition to very attractive tax measures, Québec has given Investissement Québec specific tools that enable it to act as a financial partner to businesses. Although this brochure focuses on tax issues, Québec provides businesses with a range of financial solutions that complement those offered by financial institutions. These solutions may include conventional loans, loan guarantees, non-refundable contributions or equity interests.

The information in this brochure was up to date as at April 1, 2019, and does not reflect any modifications that might have been announced subsequent to that date. Monetary amounts are expressed in Canadian dollars.

This brochure is for information purposes only. It does not substitute for legislation, regulations or orders adopted by the Québec government.

For more information, download the document below.

Next article

Under the commodity tax regime, an individual is entitled to claim an input tax credit (ITC) with respect to the purchase of goods and services only if they are used in connection with commercial activities (i.e., in the provision of taxable and/or zero-rated supplies).

A holding corporation whose sole activity is to hold investments could, therefore, not claim ITCs on its expenses since it does not carry on commercial activities because financial services are considered to be an exempt activity.

However, Section 186 of the Excise Tax Act (ETA) provides that a holding corporation that does not make any taxable supplies may claim ITCs on goods and services to the extent it is considered that they were acquired for consumption or use in relation to the shares of capital stock or indebtedness of another corporation that is at that time related to it, if that other corporation carries out commercial activities exclusively (i.e. 90% or more).

Application of this provision has led to considerable discussion with respect to the question of whether a good or a service acquired by a holding corporation can reasonably be considered to be acquired for consumption or use in relation to the shares of capital stock or indebtedness of another corporation.

Next article

These two free webinars are available until August 31st. Hurry up!

Upgrade your knowledge on recent developments in Accounting Standards for Private Enterprises (ASPE) and in International Accounting Standards Board (IASB), the IFRS Interpretations Committee and other regulators with these two webinars, which are available until August 31st, 2019.

Take note that these webinars were hosted during Fall of 2018, some information might have changed since then. The information sessions are offered in French only.

Accounting Standards for Private Enterprises (ASPE)

We will be providing an overview of the following:

  • New or revised accounting standards, including amendments to Section 1591, Subsidiaries, and Section 3051, Investments, relating to the cost method;
  • The projects and activities of the Canadian Accounting Standards Board, including the one on redeemable shares issued in a tax planning arrangement;
  • Some practical issues regarding cryptocurrencies.

Each participant who attends the webinar will be able to take a test at the end of the session.

A training certificate, which applies to training hours recognized by the Quebec CPA Order (OCPAQ), will be given to each participant who passes the test.

ASPE Webinar

International Financial Reporting Standards (IFRS)

We will be providing an overview of the following:

  • Newly published or amended International Financial Reporting Standards (IFRS);
  • Some practical issues, including those related to cryptocurrencies;
  • The IASB’s work plan;
  • Regulatory developments.

Each participant who attends the webinar will be able to take a test at the end of the session.

A training certificate, which applies to training hours recognized by the Quebec CPA Order (OCPAQ), will be given to each participant who passes the test.

IFRS Webinar