How do you finance the purchase of a business?

A buyer can identify a good business and still fail to close because the financing plan starts too late. The purchase price is only one cash requirement. The buyer also needs transaction costs, a working-capital reserve, a plan for existing debt and enough flexibility to absorb customer or employee changes after the seller leaves. Lenders will ask how the company generates cash after the transition, not just what multiple of earnings the seller wants.

First define what is being bought

An asset purchase and a share purchase have different implications for liabilities, contracts, employees, taxes and financing security. In an asset purchase, the buyer selects assets and obligations under a negotiated agreement. In a share purchase, the buyer acquires the company that owns the assets and liabilities, subject to the transaction documents. The exact consequences require legal and tax advice. For a lender, the structure affects what the borrowing entity will own, what assets it can pledge and which existing debts or charges must be dealt with at closing.

Ask what the price includes: receivables, stock, equipment, property, software, customer contracts, cash, debt, brand and goodwill. A headline price without a working-capital adjustment or debt-free cash-free convention can mislead both buyer and lender. If a target has strong profits but customers have slowed payments, the buyer may need more operating liquidity than the seller's historical statements imply.

The Canada Small Business Financing Program may finance some eligible assets in the purchase of an existing business, but the official FAQ excludes share purchases and assets acquired by a holding company under that program.² This is one example of why a buyer should identify legal structure before counting on a particular loan. Our CSBFP guide explains its limits and costs.

What can go into the financing stack?

Buyer equity absorbs risk and shows commitment, but the owner should not empty all liquid reserves simply to maximize the down payment. BDC says the appropriate contribution depends on deal size, collateral and business performance, and stresses preserving flexibility for the transition.³ A lender's willingness to provide senior debt depends on sustainable cash flow and what assets are actually available. Goodwill and customer relationships may create value yet offer limited recoverable collateral.

A seller note, often called vendor financing or a vendor takeback, can help bridge the funding gap. BDC says it is generally junior to bank debt and that bank lenders may view the seller's continued exposure positively, while the specific repayment schedule must be negotiated.⁴ A note is still debt. Interest, maturity and any balloon payment belong in the forecast. The seller must agree to the required subordination and any payment standstill before the buyer treats the note as committed capital.

A worked $4 million purchase structure

The example is deliberately tight to show the issue. An acquisition may look well funded at closing and still struggle after it. Ask what happens if a top customer reduces purchases by 15%, the seller leaves six months early or receivables take 20 days longer to collect. A credible lender package should show the owner knows which assumptions carry the deal.

What to investigate before relying on the target's earnings

BDC calls due diligence a critical part of a business purchase and recommends reviewing finances, legal matters, commercial position, technology, operations and the current owner's importance.⁵ Start with at least three years of statements and current management accounts. Reconcile revenue to customer contracts and bank deposits. Understand owner compensation, one-time adjustments, related-party transactions, cash taxes and capital spending. “Adjusted EBITDA” is an argument that needs evidence, not cash the buyer can automatically use for debt service.

The buyer should also inspect inventory age, receivables collectability and supplier terms. If the seller has reduced inventory or delayed payables before closing, the business may require cash immediately afterward. Lawyers and accountants can structure closing adjustments and representations, but management must understand the economic effect. A quality-of-earnings analysis may be warranted in a larger or more complex deal.

Customer dependence is a common risk in owner-operated businesses. If the seller is the only person with a major account relationship, forecast transition risk and negotiate a practical handover. If the buyer plans immediate growth, include the required investment rather than assuming the acquired company can finance its own expansion from day one. BDC emphasizes that post-acquisition integration often takes more time and cash than expected.⁵

What lenders will ask

1. Why this business? Show how the buyer understands its customers, operating model and risks.
2. Why this price? Provide the valuation basis, earnings adjustments and the results of diligence.
3. Where does the equity come from? Document committed funding, investor terms and cash remaining after closing.
4. What will repay each debt? Show a monthly first-year forecast and annual projections with downside cases.
5. What assets and security are available? Map property, equipment, receivables, inventory, current liens and proposed guarantees.
6. What happens after closing? Identify management, seller transition, contracts, systems and a cash reserve.

BDC lists lender questions including the seller's reason for selling, asset versus share structure, valuation, hard assets versus goodwill and financial projections for the following 12 to 18 months.³ A buyer can answer these before approaching lenders. A coherent deal room saves time and reduces the chance of several lenders asking for the same missing information at different stages.

From first offer to funding

Begin financing conversations during the early negotiation phase, after obtaining enough information to assess likely structure but before making a binding closing commitment. A letter of intent commonly establishes a framework for price, diligence access, confidentiality and a possible exclusivity period. BDC advises bringing legal, accounting and lender advisers in at this stage and notes that some LOI provisions can be binding depending on wording.⁵

Once the seller provides detailed records, run diligence and refine the valuation. Obtain conditional lender proposals showing amount, equity requirement, rate, fees, amortization, security, guarantees, covenants and conditions to fund. Confirm the seller note and any intercreditor agreement. Then negotiate the definitive purchase documents, arrange releases of old security and coordinate closing funds. A financing commitment with unresolved diligence conditions is not cash available to close.

Keep the legal agreement's timeline aligned with lender approval. If diligence finds weaker earnings or a concentrated customer base, a lower purchase price, a larger seller note or a performance-based earn-out may be more sensible than stretching senior debt. Earn-outs can also create disputes over measurement and control, so have transaction counsel document the formula and payment terms. Different sources of capital have different claims and restrictions.

Five financing mistakes that can break a good deal

1. Using the price as the whole budget. Closing fees, inventory replenishment and a cash reserve also need a source.
2. Assuming historical earnings transfer intact. Key customers, staff and the seller's work may not stay unchanged.
3. Calling a seller note equity. It is generally junior debt with a repayment date and must fit the lender's structure.
4. Overlooking the legal purchase type. An asset-based program cannot automatically fund a share purchase.
5. Optimizing only for closing. Short-term liquidity and post-close integration determine whether the company can service its financing.

For an overview of possible loan structures, see nine financing options for SMEs. If the seller's existing debt is central to the transaction, our business debt refinancing guide shows how to compare payout and new debt cost. If the business has valuable property or receivables, our collateral ranking helps frame usable security without pledging assets blindly.

The working-capital adjustment can change the cash price

Many transactions specify a target level of net working capital that the seller must deliver at closing. If the actual amount is below the agreed target, the price may adjust or the buyer may need to contribute extra cash to keep the business operating. The precise formula depends on the purchase agreement. The buyer should understand whether cash, debt, taxes, inventory and doubtful receivables enter the calculation, and how the historical target was set. An acquisition lender needs the same clarity because a dollar removed from operating liquidity can become a dollar of additional funding need.

Suppose the purchase model assumes $700,000 of net working capital, but the closing calculation shows $550,000 under the agreement. An illustrative $150,000 shortfall could reduce the price, require another funding source or become a negotiated dispute. The lender cannot underwrite the original sources-and-uses table without knowing which outcome applies. Have transaction counsel and accountants reconcile the target, closing statements and dispute mechanism before treating the cash gap as solved.

The first 100 days after closing

Financing should cover a practical transition plan. In the first month, secure banking access, payroll continuity, key supplier accounts and customer communication. Confirm which contracts require consent after a change of ownership. In the next two months, track collections against the diligence assumptions, retain crucial employees and compare actual gross margin with the purchase model. A problem discovered immediately after closing can consume the liquidity reserve quickly.

If the seller remains involved, define duties, duration, access to customers and how success will be measured. A buyer should not assume that the seller's informal relationships automatically transfer. BDC stresses that integration can require more time, money and people than expected.⁵ An extra $250,000 of reserve may be more valuable than using every dollar of equity to reduce the senior loan at closing, but the right amount depends on the target's cash cycle and risk.

Tell the lender which metrics management will monitor each month: revenue retention, gross margin, receivables aging, employee departures, inventory turns and covenant headroom. This gives the credit team confidence that risks identified in diligence will be managed rather than forgotten after funding. It also gives the owner a clear trigger to act if the acquired company diverges from plan.

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Prepare a financing story lenders can assess.

ALOS helps buyers organize the acquisition purpose, sources and uses, target financials, ownership details and repayment assumptions into a clearer lender package. Financing and final credit decisions remain with each lender.

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