How do I plan the financing when buying a small business with limited capital?

A cheaper business to buy is still a purchase, and it still needs a funding plan before you make an offer. When your own capital is limited, the plan is mostly a matter of order: work out what you can contribute, find out what a lender needs to see, and only then settle on a price and a structure. BDC advises that, as negotiations start, you should be clear about how much capital you can put toward the purchase, how much equity other investing partners can add and what terms your bank can offer. This guide walks through that order and the public programs worth knowing about.

Start with what you can actually contribute

The first number is your own. Add up cash you can commit without starving the business of working capital, any partner who would invest alongside you, and anything a relative or friend might lend. Keep those sources separate: BDC’s business purchase loan page says a financing structure may combine your own investment, a business loan and seller financing, and that BDC will assess the complete structure. BDC’s buying guidance names three things to be clear on as you start negotiations: your capital, the equity other partners can bring and the terms your bank can offer. A short written summary of all three lets you tell a seller and a lender the same story. It also shows you the gap early. If the price, plus closing costs and the working capital the business needs in its first months, is larger than what those three sources cover, you have a choice between a smaller target, a different structure or a longer search.

Know what a lender will want to see

BDC says on its business purchase loan page that it can review a financing request once you have identified a business and negotiated the main terms of the purchase, and that you and the seller must agree on a purchase price before you apply. It lists the business’s financial statements or income tax returns, the agreed price and how it was determined, and the transaction structure, such as an asset or share purchase. That list is BDC’s own, so ask every other lender you approach for its checklist early, before the price is fixed. Since BDC says it assesses the complete structure, set out your own contribution next to the price and structure when you apply, rather than asking an open-ended question about what it might lend.

How the Canada Small Business Financing Program fits

The Canada Small Business Financing Act provides that, subject to the Minister’s power to terminate that liability and to the limits elsewhere in the Act, the Minister is liable to pay a lender any eligible loss, calculated in accordance with the regulations, sustained as a result of a loan in respect of which the requirements of the Act and the regulations have been satisfied. In other words, the loan is made by the lender, and the Act deals with the lender’s eligible loss on it. The Canada Small Business Financing Regulations set out the classes a loan must fall within, including loans for real property, leasehold improvements and equipment necessary for the operation of the small business, and loans for intangible assets and working capital costs. Ask a lender whether the part of your purchase price it would finance falls inside those classes, and what security or personal guarantee it would require. The Regulations also require the lender to apply the same procedures it would apply to a conventional loan in the same amount, including, before making the loan, obtaining credit references or conducting a credit check and assessing your ability to repay.

Look at BDC and the other pieces of the stack

BDC describes a business purchase loan as intended to finance the acquisition of an existing business with revenue and an established client base, and says that, depending on the size and structure of the deal, financing may also include cash flow financing or mezzanine financing. Its buying-steps guidance lists bank debt and vendor financing among your financing options, and the loan page refers to seller financing (vendor take-back). If you combine sources, ask each lender how its loan would rank against the others and whether it will accept a seller being paid part of the price later. Our guide to vendor take-back financing explains the seller’s side of that arrangement.

Test the plan against a shortfall

With limited capital there is little room for surprises, so test the plan before you rely on it. Ask what happens if the lender approves less than you asked for, if the seller will not take any of the price over time, or if the business needs more working capital than you expected in its first months. Decide in advance which of those outcomes would send you back to the table and which would end the search. Making the offer conditional on financing is one way to protect yourself, and a lawyer can word that condition so it is clear who decides whether it has been met.

Questions to settle before you make an offer

• How much of your own capital is committed, and how much of it must stay in the business as working capital after closing?
• Which lenders will review a request for a purchase of this size, and what documents does each want from the seller?
• Does the part of the price a lender would finance fall within the purposes the Canada Small Business Financing Regulations allow, if you are considering that program?
• Will the seller accept part of the price over time, and would the bank agree to that arrangement alongside its own loan?
• Does your offer make the sale conditional on obtaining financing, and who decides whether that condition has been met?