Financing a cybersecurity services firm acquisition

A security firm may have no building or fleet of vehicles to offer as security. Much of its value may sit in contracts, people and reputation, which are hard to take as security, and the people can leave after closing. Financing may therefore turn less on what the firm owns and more on whether its cash flow will survive the change of ownership. This page looks at the acquisition from a lender’s side: what counts as security, which programs exist for this kind of purchase, how the structure of the deal affects eligibility, and how a vendor take-back and other deferred payments bridge what a lender will not fund.

What a lender can actually take as security

The tangible assets of a security firm may be modest: computers, network and monitoring infrastructure, and software licences. The CRA’s capital cost allowance classes treat general-purpose computer hardware and systems software separately from other software. Much of the value may sit in the client agreements, receivables and goodwill. A lender can take security over these through a general security agreement; the CSBFP guidelines note that in the context of Québec’s Civil Code the equivalent is a universal movable hypothec. Because client contracts may need consent to be assigned, a lender may also ask whether its security would hold up if it ever had to be enforced.

Government-backed lending and what it will and will not cover

The Canada Small Business Financing Program shares risk with lenders, and its published guidelines are specific about what a loan may finance. Computer software can be eligible equipment, on conditions the guidelines set out, and intangible assets are eligible too, defined to include goodwill when it is part of a going-concern purchase. The guidelines treat intangible assets and working capital as a capped portion of a loan; the cap sits in the guidelines and can change, so check the current terms. Two features matter for acquisitions. The guidelines state that the acquisition of shares is not eligible for financing, and they require the lender to take security on other business assets when a loan finances software, intangibles or working capital. The Business Development Bank of Canada offers a separate business purchase loan, and describes financing that can cover intellectual property, goodwill and a client list alongside cash-flow financing. Programs and limits change, so confirm both with a lender.

How the deal structure changes the financing

Because the CSBFP guidelines say the acquisition of shares is not eligible for financing, the choice between buying shares and buying assets affects more than tax. An asset purchase can make a program loan available, but each client contract meant to move must be assigned, which may mean collecting consents. In a share purchase the contracts stay with the corporation, although change-of-control clauses can still apply, and the firm’s history, including any breach exposure, stays with it. BDC lists a clear transaction structure, whether an asset purchase or a share purchase, among what it looks for in a business purchase loan request. The choice belongs to the buyer’s lawyer and accountant, but raising it early lets the financing and the purchase agreement be built around the same answer.

Where a vendor take-back and an earn-out sit

A vendor take-back is a note from the buyer to the seller for part of the price, and where it ranks relative to the lender’s own security is a point to settle with the lender. The program guidelines state that the amount a vendor finances is not eligible for a program loan, so the seller’s note sits beside the loan rather than inside it. An earn-out ties part of the price to the firm’s performance after closing, so, depending on how it is drafted, the buyer can pay less if key clients leave. Both devices give the seller a continuing interest in a smooth handover, and both need drafting that says exactly how retention, and any dispute over it, will be measured.

Cash flow and working capital after closing

If retainers are billed monthly or in advance and project work on milestones, cash can arrive unevenly. A buyer who has spent everything on the purchase price can run short on payroll, tools and the transition period even when the business is sound. The program guidelines separately describe a line of credit for working capital costs, so ask lenders whether a working capital facility can sit beside the acquisition loan. The cost of replacing an analyst during a hiring gap, and of re-papering client contracts after closing, belongs in the buyer’s cash plan.

What to have ready for a lender

• Contracts that show renewing revenue, with renewal dates and the share that needs client consent to assign.
• Evidence that the analysts who deliver the work are employed, staying, and bound by agreements that protect the firm’s intellectual property.
• Insurance schedules showing professional and cyber liability cover, and how cover continues after the sale.
• A clean incident record and no unresolved claims, because a lender is lending against cash flow that a large claim could consume.
• An accountant’s recast of earnings, with owner compensation restated to a market cost for the work done.