Financing a business purchase in BC: bank loans, government-backed loans and seller financing

Few people buy a business with cash alone. Most combine a down payment with one or more loans, and the lender's terms quickly become part of the transaction: what you can buy, how the deal is structured, what you must sign and when you can close.

This article looks at the main financing routes for buyers in BC, what the federal Canada Small Business Financing Program currently covers, and the legal documents and conditions that come with borrowing to buy.

Start with the structure of the deal

Before you talk to lenders, know whether you are buying the assets of the business or the shares of the company that owns it. Lenders treat the two differently, and at least one government-backed program will not finance a share purchase at all. Our article on share purchase or asset purchase explains the difference.

Lenders also want to see that the price makes sense. Expect to provide the business's financial statements or tax returns, your own tax and credit history, a business plan, and a signed letter of intent setting out the price and proposed closing date.

Conventional bank and credit union loans

A term loan from your bank or credit union is the usual starting point. The lender decides how much it will advance against the business's assets and cash flow and how much equity you must put in. In practice the commitment letter will typically require:

• Security over the business's assets, usually a general security agreement registered in the Personal Property Registry, and a mortgage if land is involved.
• Personal guarantees from the people behind the buyer.
• Conditions before funding, such as an assignment or new lease, insurance, an appraisal, and copies of the signed purchase agreement.
• Ongoing covenants, such as financial ratios, reporting and limits on paying other debts or dividends.

Under BC's Personal Property Security Act, a security interest is enforceable against third parties only if the debtor signs a security agreement describing the collateral, which can be done by a statement covering all of the debtor's present and after-acquired personal property (s 10(1)(d)). Registration of a financing statement perfects it (s 25), and between perfected interests in the same collateral the general rule is that the first to register has priority (s 35(1)(a)). That is why the bank will insist on registering early and ranking first.

The Canada Small Business Financing Program

The CSBFP is a federal program that shares the risk of loans made by participating banks, credit unions and caisses populaires. The lender, not the government, approves the loan and provides the money. According to the program's current pages:

• Who qualifies. Small businesses and start-ups operating in Canada with gross annual revenues of $10 million or less, other than farming businesses.
• Buying a business. Buying the eligible assets of an existing business may qualify, financed up to the lesser of the purchase cost and the appraised value of those assets. Share purchases, and assets acquired by a holding company, are not eligible.
• Limits. The maximum for one borrower is $1.15 million: up to $1 million in term loans and $150,000 in lines of credit. Of the term loan amount, no more than $500,000 can be used for leasehold improvements and equipment, and within that, no more than $150,000 for intangible assets and working capital.
• Costs. A registration fee of 2% of the amount loaned, which can be financed. Interest is capped: for floating-rate term loans, the lender's prime rate plus 3%.
• Security. The lender must take security on the assets financed, or for some uses on any business assets, and may take a personal guarantee.

If much of the price is goodwill, the cap on intangible assets is worth checking with the lender early. The program changes from time to time, so confirm the current rules before you rely on them.

BDC and other lenders

BDC (the Business Development Bank of Canada) offers financing to buy an existing business, including management or employee buyouts, family transfers and refinancing seller financing. Its application checklist asks for a clear transaction structure, an agreed price and how it was set, a letter of intent with an expected closing date, the down payment, your notices of assessment for the past two years and the business's financial statements or tax returns. If a BDC loan sits alongside a bank loan, the two lenders will need to agree on security and priority between themselves.

Seller financing, briefly

Sometimes the seller agrees to take part of the price later, with interest, secured against the business. This can bridge a gap between what the bank will lend and the price. Lenders will usually require the seller's claim to rank behind theirs, and the seller will want security and default terms of their own, so the seller financing needs its own documents and must fit with the bank's.

Fitting the financing into the purchase agreement

Borrowing affects the deal itself. The purchase agreement should include a financing condition with a realistic deadline, and the closing date should leave time for the lender's conditions. The lender's requirements, such as the lease, insurance, registrations and personal guarantees, become items on the closing agenda. Your due diligence also matters to the lender: unresolved liens, tax debts or lease problems can delay or stop funding.

Read the commitment letter as carefully as the purchase agreement. Personal guarantees, covenants and default terms often outlast the purchase by years.

Buying a business with borrowed money? Line up the legal side before you commit

Our business purchase and sale lawyers can review your letter of intent and lender commitment letter, draft financing conditions into the purchase agreement, and coordinate the security, personal guarantees and closing documents with your lender.

Call 604-259-2844 or send us a message to arrange a consultation at our Vancouver office.