Part III: Buying an Ongoing Business
By Eugen Klein, B.Comm(UREC), CRES, ARM®, RI, FRI
Real Estate Broker
When considering whether to start a new business from scratch or buy into a business that is in operation, one must consider the question of financing. Very rarely do purchasers have adequate cash to be able to start out-right, and to handle the ongoing drain on resources which preceeds revenue flow. More favourable financing terms are always available to the buyer of an established business because of these advantages: existing customer base, experienced employees, established market position and tested systems. There are also a wider range of financing options uniquely available; such as vendor financing and financing by suppliers of the business.
As an advantage to the purchaser, financing an ongoing business makes the vendor, banker and suppliers in essence partners in the business, sharing some of the risk. Every creditor feels more secure with an established entity and most banks do not finance new start-ups at all. For on-going businesses, vendor financing at below-market rates is commonly available without the same security requirements as other arms-length lenders.
A buyer of a going concern often has immediate cash flow. In fact, in most cases, that’s what has been carefully protected by the financing partners: the vendor, the bank, and the suppliers. These lenders will only agree to participate in transactions that make sense to them. They know they won’t get paid unless the cash flow works for the new business owner – which also gives them a strong vested interest in seeing the purchaser succeed. Contrast this with a new start-up, where the buyer must fund the start-up for months and sometimes even years until the business gets going. Most start-ups fail, in fact, because they run out of money as they are in the process of succeeding.
Overall, there is less risk in purchasing a business than in starting one, even if there are major areas which need improvement.
Why do people start new businesses? Some people can genuinely see a new need in the marketplace and fill it. Sometimes, there are no businesses for sale in a certain category. But, in many cases the reasons for starting one’s own businesses from scratch can usually be found in ego. One should be careful that the logical reasons to start a business from scratch do not exist simply to rationalize an emotional decision based on personal pride.
One common rationalization is that the prospective entrepreneur wants a “clean business” without the inherent liabilities of a going concern. In truth, it is better to take over an operation where the liabilities or flaws are well known, rather than to start something new and proceed in ignorance. Asset sales are always a possibility instead of share sales so that no legal liabilities are assumed. In the best of situations the problems in a business may actually be an advantage to the purchaser who wins in two ways – firstly by obtaining a reduction in price or discount on the assets because of the liabilities of the business, and secondly by starting from a position of debt, allowing future profits to be written off. Very often a seller may be experiencing difficulties because of a lack of resources or in a part of the business that is outside their area of expertise. If the purchaser has the right expertise and is well positioned, such opportunities are a virtual goldmine.
The idea that there are operational systems that can’t be changed is usually wrong; small businesses are usually quite flexible and changeable. Employees usually welcome enlightened change, and consulting with the best employees can provide valuable insight. One should become familiar with business systems during the due-diligence period of the transaction and should make sure that an extended training period by the vendor is specified. The best technologies often evolve over time and through experience, neither of which are available to new businesses. This is one of the greatest hidden costs of the ego-driven start-up.
The most commonly given reason for starting from scratch, however, is to avoid paying for “goodwill” or “blue sky”. In reality, you will pay for it one way or the other. Either the vendor is paid for goodwill or you have to put in lots of extra money into working capital to develop goodwill yourself. There is no free lunch.
I am continuing my articles on buying a business: this month is part III; the final installment follows next month. You will also find a continuation of the article provided me by the good people at Net Finance. It will similarly end in the December Prosperitas.
The investment opportunities this month are all commercial properties. Where possible, I have included the address of the property, so that if something piques your interest, you may drive by and have a look. Most of these properties are income generating, that is, tenanted. If you do take a look in person, please do not try to speak to the tenants. Tenants become uncertain of the future of a building if they believe it is for sale or changing hands; this can create tension which our clients do not want; in any event, it is unlikely that the tenants would be able to answer any of your questions.
As always, you are welcome to contact me any time with your questions and concerns regarding the disposition of your commercial investments or businesses.
Eugen L. Klein
B.Comm (UREC), CRES, ARM®, RI, FRI
Corporate Finance II – Tiered Financing Approach
By Mark Eikeland, CGA
Editor’s Note: This is the second in a series of articles on corporate finance.
Small business financing is a financial puzzle with many pieces. This has given rise to another increasing trend: “tiered or layered” financing using multiple funding sources. This is a well used strategy common in big business financing, but now we see a version of this strategy being used more frequently in small business. Now even small operating lines of credit under $500,000 can be split between two different banks; one bank in the senior position with security and the other in an unsecured position providing “top up” financing.
The following example illustrates how this “tiered financing approach” could be used. At first this may seem to be an extreme view of this approach but this is a very real scenario in today’s marketplace. The purpose here is not to go into any detailed technical description of each financing product but to demonstrate how some of the financing products can and are being used.
A small business financing program might include some, all or more of the following products:
1. Operating Line – Secured
This is a cornerstone to any mature business financing program. As a primary financial product, a lead bank is the funder and typically margins the facility on inventory and accounts receivable. Rates are low starting at prime.
2. Operating Line – Unsecured
There are many opportunities to “top up” a line of credit (LOC). A second lender comes in on an unsecured basis to “top up” working capital with an unsecured operating LOC. This is used to supplement the primary operating line. This works well when a business is experiencing a growth spurt or has seasonal cash flow swings. Rates can start at prime plus two percent.
3. Factoring Facility (margin excess)
A factoring program turns a company’s accounts receivable invoices into immediate cash. The factoring company buys the company’s invoices for cash and charges a fee. A carrying cost discount rate is applied and charged until the customer pays the invoice, usually directly to the factoring company. This is especially useful where a growth spurt has consumed the entire LOC facility, yet there may be excess margin available that otherwise could not be used. Rates can start at two percent per month or one per cent for every ten day period that the invoice remains unpaid.
4. Capital Term Loan – Secured
This is the traditional long term capital asset financing program that is senior and fully secured by capital assets. In the past the same bank providing the operating loan was usually expected to provide this financing product as well. Today this is an opportunity to introduce an alternative lender and reduce overall exposure to any one financial institution. And, in many cases, this can be achieved with better terms, rates and conditions. Rates can start at prime plus one percent.
5. Capital Lease – Secured
Capital leases are commonly used for acquiring specialized equipment, in specialized industries or in cases where attractive terms such as 100% financing is available. Very often “in-house” dealer programs make acquiring capital assets with a lease very easy. Sale lease-backs are often used here to turn equity in equipment into cash. Rates can vary significantly here and are dependant upon several factors.
6. Working Capital Term Loan – Unsecured
Working capital loans are used in situations where sales are expanding and the company needs additional working capital to support the sales growth. In this case, the company assets are already fully secured with senior debt. As a result, this specialized type of financing is based on cash flow and debt serviceability, and is essentially unsecured. Rates can range from prime plus four percent to prime plus 14 percent due to lender’s risk.
7. Operating Lease – Secured
The operating lease is easily available and is typically used to acquire small to mid-size
equipment. This very often comes with no money down options and so, is a very attractive financing alternative. With proper planning, larger equipment leases can be structured as operating leases for financial statement purposes. All leases, even capital leases, are now treated as operating leases for tax purposes; this can present some significant tax planning opportunities. Rates can vary significantly.
The premises lease is included here and is how leasehold improvements are most appropriately financed. In most cases the landlord is willing, and is best able, to provide some financing on the project over and above negotiated tenant inducements. If applicable the landlord can simply adjust the lease obligation to reflect the additional investment.
Mark Eikeland, CGA, is president and founder of www.NetFinance.ca, an on-line full service corporate finance resource for accountants and accounting firms throughout BC and Alberta. This area of his practice focuses specifically on corporate finance, and is where clients are assisted in financing their start-up, acquisition, re-organization, and expansion plans. Visit www.NetFinance.ca for more information.
1. 1926 WEST BROADWAY
Vancouver; 10,000 + 1000 sq. ft. $220,000 net income. Tenancies are stable and long-term. One vacancy.
2. 2485 MONTROSE AVENUE
Abbotsford; 9,000 sq. ft. building on 1.07 acres land in downtown Abbotsford. Re-zoned C7, allowing mix-use com/res up to 2.75 FSR.
3. 30488 GREAT NORTHERN AVENUE
Abbotsford; Class A building for various uses. 4,000 sqft office, 10,000 sqft warehouse w/22ft ceilings, on 1 ac. land in bus. park.
4. 2026 QUEEN STREET
Abbotsford Industrial lot; 1.73 acres, just north of Abbotsford Airport, zoned A1. Opposite side of Queen zoned I2-I6
5. FRASER VALLEY GAS STATION
Excellent Esso gas station in downtown Abbotsford. ½ acre of land, 1500 sq. ft. office & gas bar .
6. 44290 YALE ROAD
Warehouse strata units in industrial section of Chilliwack; Yale Rd; next to hwy. 6000 sq. ft. total. Excellent location.
7. 8 – 19299 94TH AVENUE
North Surrey manufacturing premises; 3540 sq ground floor & 1700 sq.ft. mezzanine. Office & showroom incl.
8. #103 – 8988 FRASERTON COURT
In South Burnaby Business Park; 2,109 sq. ft. incl. 606 sq. ft. mezzanine. Currently in use as high tech music studio.
9. 5446 VEDDER ROAD
Chilliwack; 2600 sq. ft. office; can have variety of commercial use; live-work in conj. With 5456 & 5462 Vedder Rd.
10. 7937 ENTERPRISE ROAD
Chilliwack; 50,000 sq. ft. lot in new business park. Wide variety of uses, close to hwy, visibility, easy access.
11. WHISTLER LEASE SPACE
30,000 sq. ft. light industrial/service retail space: 17 units, varying size, $15 – $18 psf. Located just off Hwy 99 in Function Junction, Whistler.
12. ABBOTSFORD AUTO MALL LEASING
Retail & service bays available in auto mall. Easy access and great visibility; perfect for any auto sales/service/accessories related business.
13. 46135 4TH AVENUE
Chilliwack; zoned CM-1. Good rents; located in older industrial area, new dev. Taking place. 4,000 sq. ft.
14. SURREY COMMERCIAL STRATA
Retail Commercial Centre at 72 Ave & 125 St. 1300 to 3880 sq. ft. All units have high ceilings & good frontage.
15. 5456 VEDDER ROAD
Chilliwack; 2000 sq. ft. retail space; great development in conjunction with 5446 & 5462 Vedder Rd.
16. 5462 VEDDER ROAD
Chilliwack; 2,000 sq. ft. residence. Live-work in conj. with 5446 & 5456 Vedder Rd
17. 206 – 938 HOWE STREET
Vancouver; opposite BC Supreme Court. Perfect for independent professional. Parking space included.
18. LANGLEY OFFICE/RETAIL LEASE
#114 – 6080 200th St. Excellent lease space, busiest corner in Langley. 6400 sq. ft. on two floors. Ample parking.
19. #1 – 31716 SOUTH FRASER WAY LEASE
Abbotsford; sublease, 7455 sq. ft. incl warehouse, office & retail. Currently used as automotive, close to freeway.
20. ABBOTSFORD OFFICE/WAREHOUSE LEASE
34581 4th Avenue; 1800 sq. ft. warehouse & 400 sq. ft. office. Border proximity, good for light industrial / trucking.
“For your really professional work in marketing our business in British Columbia, we would like to thank you once in a very special way. Since a very long time we are in business with professionals like you and your crew, but never before we have seen the commitment for doing a good job in selling a property like in your case.”
Credit Suisse Banking, Switzerland
“I have known Eugen for many years through the Real Estate Institute of Canada, professionally, and the Real Estate Board of Greater Vancouver. I have always found him to be hard working, honest, technically savvy, ethical and professional. I can wholeheartedly recommend him for his innovative and creative ideas and the implementation of those strategies and plans.”
Mercedes Wong, CPA, CCIM, FRI, RI(BC)
President, Commercial Division, REBGV
“I greatly appreciated your recent article in REM Magazine. You have identified and articulated the issues that business owners face and subsequently the challenges that business brokers and Realtors confront in marketing those businesses. Keep up the good work; I look forward to reading more!”
Commercial Realtor, Peterborough, ON
“I have known Eugen Klein for approximately fifteen years. I am impressed by his commitment to life and all its opportunities and challenges. By my experience he is hard working, honest, intelligent, sincere and courteous.”
John Windsor, R.I.(B.C.), F.R.I.C.S.
President, North American Property Corporation
My ‘Community’ section is dedicated to the extraordinary people who have contributed to my life with exceptional service. I would like to share my good fortune of knowing them with you. Please feel free to convey my recommendation.
Mr. Jesse Bannister
New Westminster (604) 519-0333
BANK OF MONTREAL
Mr. Joe Corrado & Mr. Mark Tower
Vancouver (604) 665-2682
CAPITAL WEST MORTGAGE
Mr. Daymon Eng
Vancouver (604) 899-3799
Mr. Grant Gilmour
Langley (604) 888-4200
CIBC RESIDENTIAL FINANCE
Mr. Adam Beaudin-Ball
West Vancouver (604) 981-2549
CIBC RESIDENTIAL FINANCE
Mr. Derek Christiansen
Vancouver (604) 220-6161
Mrs. Valerie Orr
Vancouver (604) 605-4339
Mr. Gary Khangura
Vancouver (604) 879-0235
CYPRESS INSPECTIONS LTD.
Mr. Noel Murphy
West Vancouver (604) 312-8606
Mr. Jason Romo
Vancouver (604) 420-3400
FLOWFORM DESIGN GROUP
Mr. George Verdolaga
Vancouver (604) 321-8008
GRAPHIC DESIGN & ART WORK
Mr. Denis Meyer Jr.
Burnaby (604) 777-0550
MAHOVLICH MARBLE & GRANITE
Mr. Frank Mahovlich
Vancouver (604) 293-0093
MCKITRICK CLARK MCLEOD
Mr. Bruce J. Preston
Vancouver (604) 736-6717
NATIONAL HOME REVIEWS
Mr. Dean Kazoleas
Vancouver (604) 681-2108
PINK LIME SALON & SPA
Mr. Youssef Jawhari
Vancouver (604) 683-7444
PLAN-IT WITH US TRAVEL
Mrs. Pam Gosal
Richmond (604) 916-8044
RENOVATIONS & APPRAISALS
Mr. Chris Lewin
North Vancouver (604) 562-5799
Mrs. Vanessa Stenner-Campbell
White Rock (604) 535-4749
VANCITY CREDIT UNION
Mr. Joe Chan
Vancouver (604) 877-8296
VANCITY VENTURE CAPITAL
Mr. Axel Christiansen
Vancouver (604) 877-6582
Eugen L. Klein
B.Comm (UREC), CRES, ARM®, RI, FRI
Toll Free: 1.800.818.8599
Please do not hesitate to call me at 604.818.5888; it is my pleasure to serve your real estate needs. Please visit us on the world wide web at www.eugen-klein.com