Acquiring an existing business can be both exciting and daunting. Finding the right financing can mean the difference between a smooth takeover and a deal that never crosses the finish line. To illustrate how different financing approaches can work, let’s follow the fictional story of Alex, an aspiring entrepreneur who wants to acquire a small manufacturing company in Toronto. We’ll see how six distinct financing paths play out—and explore their pros, cons, and ownership structures using a simplified cap table.
Background: The Target Company
- Business Name: Ontario MetalWorks (OMW)
- Industry: Custom metal fabrication for commercial clients
- Annual Revenues: $2.5 million
- EBITDA: $400,000 (approx.)
- Sale Price: $1.5 million (roughly 3.75× EBITDA, includes some inventory and equipment)
OMW has a loyal customer base, a skilled workforce of 15, and an owner, George, who’s ready to retire after 30 years in the business. Alex believes this is a prime opportunity: loyal clients, steady cash flow, and expansion potential.
Financing Path #1: Traditional Bank Loan
Purchase Price: $1.5 million
- Bank Loan: 70% ($1.05M)
- Buyer Equity: 30% ($450k)
- No External Equity
- No Seller Note
Pros
- Lower Interest Costs: Major banks often offer competitive interest rates.
- Simpler Deal Structure: Only the buyer and the bank are involved.
Cons
- High Personal Cash Outlay: $450k required from Alex.
- Personal Guarantee: The bank may require collateral and a personal guarantee from Alex.
Outcome
- Straightforward Closing: With a sizable down payment and a healthy target company, banks are typically comfortable.
- 100% Ownership: Alex owns the business outright, with no outside investors or seller note.
Cap Table
Since there are no external investors, the buyer (Alex) retains 100% of the equity.
- Buyer (Alex): 100%
(Bank financing is treated as debt; it does not affect equity ownership.)
Financing Path #2: Bank Loan + Seller Financing
Purchase Price: $1.5 million
- Bank Loan: 65% ($975k)
- Buyer Equity: 20% ($300k)
- Seller Note: 15% ($225k)
Pros
- Reduced Upfront Equity: Alex only needs $300k in personal funds.
- Aligned Interests: The seller remains partially invested in the business’s success until the note is repaid.
Cons
- Seller Appetite: Some sellers want a clean break with no ongoing financial tie.
- Bank Requirements: The bank typically requires the seller note to be subordinated (i.e., repaid after the bank).
Outcome
- Smooth Transition: The seller often stays involved short-term, guiding Alex while the note is active.
- Buyer Retains 100% Equity: No external equity investor exists here.
Cap Table
Since there are no external investors, the buyer (Alex) again retains 100% of the equity.
- Buyer (Alex): 100%
(Seller financing is treated as debt, not equity.)
Financing Path #3: Bank Loan + Seller Note + Buyer Equity + Friends & Family Equity
Purchase Price: $1.5 million
- Bank Loan: 65% ($975k)
- Seller Note: 10% ($150k)
- Buyer Equity: 10% ($150k)
- Friends & Family Equity: 15% ($225k)
Investor Equity Step-Up:
For Friends & Family, we will apply a 2× step-up to their equity investment when calculating final ownership:
- Investor’s “Value” = $225k × 2 = $450k
- Investor Ownership = $450k / $1.5M = 30%
- Buyer Ownership = 70%
Pros
- Lower Personal Investment: Alex invests only $150k.
- Shared Risk: Friends & Family (F&F) share both risk and potential upside.
Cons
- Personal Relationships: If the business faces challenges, it can strain these personal ties.
- Multiple Stakeholders: Alex must keep friends & family informed and manage expectations.
Outcome
- Moderate Debt: With a 65% bank loan plus a 10% seller note, monthly obligations are balanced.
- Collective Upside: If OMW grows, F&F receive returns proportional to their 30% ownership.
Cap Table
| Party | Ownership Calculation | % Ownership |
|---|---|---|
| Friends & Family | (Investor Equity × 2) ÷ Purchase Price = (225k × 2) ÷ 1.5M = 450k ÷ 1.5M | 30% |
| Buyer (Alex) | Remaining Ownership = 1 − 30% | 70% |
Financing Path #4: Bank Loan + Seller Note + Buyer Equity + Angel Investor
Purchase Price: $1.5 million
- Bank Loan: 60% ($900k)
- Seller Note: 10% ($150k)
- Buyer Equity: 20% ($300k)
- Angel Investor Equity: 10% ($150k)
Investor Equity Step-Up:
For the Angel Investor, we apply the same 2× step-up:
- Investor’s “Value” = $150k × 2 = $300k
- Investor Ownership = $300k / $1.5M = 20%
- Buyer Ownership = 80%
Pros
- Strategic Expertise: Angel investors often bring industry knowledge and valuable networks.
- Moderate Buyer Outlay: Alex invests $300k, less than the 30% he’d need if no investor were involved.
Cons
- Equity Dilution & Control: The angel typically wants voting rights or a board seat.
- Exit Pressure: Angels usually aim for liquidity (sale, buyout, or significant dividends) within 5–7 years.
Outcome
- Accelerated Growth: Additional capital and strategic guidance can help OMW enter new markets faster.
- Shared Decision-Making: Alex must align with the angel’s strategic priorities.
Cap Table
| Party | Ownership Calculation | % Ownership |
|---|---|---|
| Angel Investor | (Investor Equity × 2) ÷ Purchase Price = (150k × 2) ÷ 1.5M = 300k ÷ 1.5M | 20% |
| Buyer (Alex) | Remaining Ownership = 1 − 20% | 80% |
Financing Path #5: Bank Loan + Buyer Equity + Seller Note + Earn-Out
Purchase Price: $1.5 million
- Bank Loan: 60% ($900k)
- Buyer Equity: 20% ($300k)
- Seller Note: 15% ($225k)
- Earn-Out: 5% ($75k) tied to future performance
(No external equity investors, so no step-up required.)
Pros
- Lower Immediate Debt: Part of the price is deferred via a seller note and earn-out.
- Performance-Based Payment: If the company surpasses agreed-upon targets, the seller receives the additional $75k.
Cons
- Complex Legal Structure: Multiple documents for the note, earn-out metrics, and bank financing.
- Potential Disputes: Earn-outs require crystal-clear benchmarks (revenue, EBITDA) to avoid conflicts.
Outcome
- Win-Win: If OMW excels, the seller benefits; Alex only pays the extra earn-out if the business truly grows.
- One Equity Owner: Alex retains full ownership with no external equity partners.
Cap Table
No external equity investor.
- Buyer (Alex): 100%
Financing Path #6: Bank Loan + Seller Note + Buyer Equity + Investor Equity + Earn-Out
Purchase Price: $1.5 million
- Bank Loan: 60% ($900k)
- Buyer Equity: 10% ($150k)
- Investor Equity: 10% ($150k)
- Seller Note: 15% ($225k)
- Earn-Out: 5% ($75k)
Investor Equity Step-Up:
For the outside investor, we apply the same 2× step-up:
- Investor’s “Value” = $150k × 2 = $300k
- Investor Ownership = $300k / $1.5M = 20%
- Buyer Ownership = 80%
Pros
- Shared Financial Burden: Alex only invests 10% personally, and the bank loan covers 60%.
- Deferred Payments: Both a seller note (15%) and an earn-out (5%) reduce immediate cash outlay.
Cons
- Equity Dilution: The external investor ends up with 20% ownership due to the 2× step-up.
- Complex Structure: Multiple legal agreements for the note, earn-out, and investor equity.
Outcome
- Performance Alignment: If OMW meets certain milestones, the seller gets additional earn-out proceeds.
- Strategic Support: The outside investor may offer expertise or networks, but requires an ownership stake.
Cap Table
| Party | Ownership Calculation | % Ownership |
|---|---|---|
| Investors | (Investor Equity × 2) ÷ Purchase Price = (150k × 2) ÷ 1.5M = 300k ÷ 1.5M | 20% |
| Buyer (Alex) | Remaining Ownership = 1 − 20% | 80% |
Key Takeaways
- Multiple Financing Tools
Bank loans, seller notes, equity partners, and earn-outs can mix and match to optimize cash flow and manage risk. - Equity Step-Ups
When outside investors are involved, a 2× step-up can significantly alter final ownership percentages. Always clarify how these step-ups are valued against the total purchase price. - Buyer Guarantees
Where bank debt is involved, the buyer typically guarantees that loan, effectively increasing their share of responsibility (and risk). - Strategic Fit
Each deal structure should align with your appetite for control, your risk tolerance, and your growth plans.
Conclusion
As Alex’s journey shows, there is no single “best” way to finance an acquisition. Whether you rely on traditional bank loans, investors, seller notes, earn-outs, or a blend of all these methods, each strategy has implications for equity ownership and operational control.
- If you want full control, consider a higher bank loan and more buyer equity.
- If cash is tight or you seek specialized expertise, investors and seller financing can lighten upfront costs and provide added resources.
- If you need performance alignment, an earn-out can keep the seller motivated post-sale.
By understanding how debt, equity, and investor step-ups intersect—and how each party’s stake is calculated—you can more confidently structure a deal that sets your new acquisition up for lasting success. Good luck on your entrepreneurial journey!
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Disclaimer: The information provided in this blog post is for general informational and educational purposes only and does not constitute legal, financial, or investment advice. Every business situation is unique, and regulations vary by jurisdiction. Therefore, you should seek professional guidance tailored to your personal circumstances. Neither the author nor any associated parties accept any liability for loss or damage resulting from the reliance on or use of this information
