Financing a developer tools or API business acquisition

A developer tools or API business can give a lender very little to lend against in the traditional sense. There may be no building, no fleet and little equipment; the value sits in code, accounts and a stream of usage-based revenue that rises and falls with customers’ own volumes. That shapes everything about financing it: what a lender will take as security, which government programs can help, how the buyer’s corporate structure is set up and how much of the price is tied to the seller. This guide looks at the deal through the lender’s eyes, quoting the lender’s own tests where a public source states them.

What a lender can take security over

With few physical assets, security is the hard question. The federal guidelines for the Canada Small Business Financing Program say that obtaining proper security on computer software, intangible assets and working capital can be problematic, and that when a loan finances those items the lender must also take security on other business assets, even where those assets are already subject to prior charges. The same guidelines say lenders are expected to apply the same due diligence they would to a conventional loan. It helps to have the lien search, the contract list and the evidence of code ownership ready alongside the financial statements.

What the Canada Small Business Financing Program covers

The program makes it easier for small businesses to get loans from financial institutions by sharing the risk with lenders. Its guidelines list eligible costs, and several fit a software purchase: they treat computer software, including a custom-made package, as eligible if the conditions in item 4.1.3.1 are met, including that it is designed and developed by a specialized contractor or vendor and that the borrower ends up owning it or holding a licence to use it, and they list goodwill as an intangible asset when it is part of a going-concern purchase. They also cap how much of a term loan may go to intangible assets and working capital, so a price made mostly of goodwill and code may not fit entirely inside the program. Working-capital costs can also be financed with a CSBF line of credit, which may be used only for that purpose. Whether the code and platform you are buying fall into those categories is for the lender and the guidelines to settle; see whether the CSBFP covers buying a business.

Why the borrowing entity matters

The guidelines also say a holding corporation is not an eligible borrower because it does not operate a business, so a buyer planning to acquire through a new holding company needs to settle early which entity borrows. One answer is to combine the vehicle and the target after closing. Corporations Canada describes amalgamation as the process by which corporations merge and carry on as one, and says that for an application to be processed all of the amalgamating corporations must be incorporated under the Canada Business Corporations Act. It describes continuance as the way an incorporated business effectively re-incorporates under another legislation, so a target formed under a provincial statute would need to look at continuance, or at its own province’s rules, before the federal route is available. Our answer on amalgamating a holdco with the business it bought explains the effect.

What BDC says it will finance

BDC presents a business purchase or transfer loan for buying an existing business, completing a management or employee buyout, or acquiring a competitor, and it mentions extra financing for intellectual property, goodwill and a client list. It says the business being bought must be Canadian and generating revenue. Those categories map closely onto a developer tools company, where the code and the customer base can be most of the asset, but eligibility and terms are BDC’s to decide, and a lender’s own policy on advance rates or security is never something to assume from a general description.

Seller-linked terms

Because usage-based revenue can move after closing, a deal can tie part of the price to the seller. BDC says that for an owner who wants continuity there can be a benefit to staying involved through vendor financing, an earn-out or a phased transfer of ownership, and that buyers may insist on a reduced price if the seller cuts all ties. In this sector an earn-out is only as good as its definition of the revenue being measured. The metering that produces the number has to be written into the agreement and be reproducible, or the earn-out becomes the dispute. Our glossary entry on earn-outs and the answer on missed earn-out targets cover how they work.

What to have ready for the lender

A lender asking for customer lists, usage data or contracts is party to a business transaction as PIPEDA defines it, because the definition includes the making of a loan or the provision of other financing to an organization. The section 7.2 conditions for sharing personal information without consent therefore apply to that disclosure as they do to a buyer, which is another reason to offer aggregated usage data in the first round. A prepared package might include the following.

• A reconciliation of usage, invoices and bank deposits for a run of months, ideally prepared by the seller’s accountant.
• A contract list showing term, commitment and assignment or change-of-control terms for each major customer and vendor.
• Evidence of who owns the code, the marks and every account the service runs on.
• A cutover plan showing how accounts, keys and on-call responsibility pass to the buyer on closing day.
• A working-capital picture that shows when cloud bills fall due compared with when customers pay.