Seeking Advice on Financing Strategy for Seasonal Business Acquisition

July 23, 2024

by a searcher from University of Illinois at Urbana-Champaign in Chicago, IL, USA

I am a self-funded searcher and military veteran looking to acquire my first company. I have a potential off-market deal and recently met with the seller to discuss their business. We really hit it off, and he strongly believes I am the right person to take over.

There are a few risks in this business. First, there are brand licenses connected to the products he sells, and those contracts need to be renewed every few years. Next is sales channels through major retailers who buy these products and whether that relationship can be transitioned. I will likely tie the transition of the relationships, and revenue fluctuations to the seller note to ensure we are aligned and risk is mitigated.

These lead to the ultimate challenge of seasonality. This is a gift business, and 90% of its revenue comes in September/October for the holiday season. This means the first 10 months of the year are fronted by the seller using a line of credit (LOC) and their personal cash. They have to pay for all licensing, inventory, and overhead costs up front. They currently have a $9 million credit line and need a $15 million credit line so they aren’t pulling money out of their own pocket.

The business is doing about $2.5 million in EBITDA, and the seller wants a 5x multiple but is open to negotiation. My initial thought was a stock sale with a 4x multiple to ensure all the licenses and contracts transfer. I am still analyzing this.

My questions are:

1. Has anyone here acquired a business with high seasonality? If so, did you use bank financing for the deal?
2. How did you manage cash flow, considering the business earns the majority of its revenue in just two months while debt obligations are due monthly?
3. Is securing a $15 million LOC feasible? Are banks open to offering a 1-year delayed payment on an LOC and business loan until the first revenue season is complete? The business has been growing every year so I’d look for LOC growth opportunities as well so I don’t get into his position of needing to use personal finances to fund growth.
4. I’m considering a financing mix of SBA loan, substantial seller financing, potential mezzanine debt, and a large LOC. Any advice on this mix.

Any insights or experiences would be greatly appreciated!

Thanks in advance for your help.

Reply by a professional
from University of New Brunswick in Saint John, New Brunswick, Canada

Hi James - One of the businesses i've purchased had seasonality, although not nearly to the same extent. After reading this, 1) the first thought that comes to mind is that there is a lot of transition risk and that the seller plays a major role post sale. I would go a step beyond VTB and look at earn outs and profit sharing (or even cash-flow sharing). I'd look at a 51% or majority control purchase with a 3-5 year earn out depending on his willingness to stay on and your ability to pitch your value add to the business. For the 51% i'd do a mix of seller financing (bulk of it) and some cash (as little as possible). I live in Canada, but I believe SBA is off the table for partial purchases. Then for LOC I would negotiate that you split the PG with him or your refinance it to your own bank and negotiate with him on splitting the PG. With him having skin in the game, I am sure banks would come to the table since the business "should" perform better with you at the table. The big question is, are you comfortable personally guaranteeing that amount of debt and do you have the PNW to back it? If not, then you'll need an investor at the table. I think you'll have to get very creative on this deal to make it work because cash-flow seems like it will be a major challenge, bringing me to point 2) A $9M LOC fully utilized is $720k of interest at 8%, then add in VTB payments (let's say you get the 4x multiple, buy 51% of the shares using $3M VTB and $1M cash on a 5 year 8% vtb) that's another $750k in payments. I would design the entire deal/payout structure around cash-flow triggers, it would keep everyone aligned on the one thing that will sustain/kill it and motivate everyone to figure out how to re-design the business model to become less dependent on debt. Hope that helps

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I like Scott's approach as well. From a financing perspective, we have financed numerous business acquisitions with seasonality, and getting them financed is typically not a problem. However, it is rare to see one needing this much of a line of credit in advance. It will be hard to get lenders comfortable with that large a line of credit. The other issue you will have in using SBA financing is that you would need to have the SBA lender get comfortable with releasing the A/R and/or inventory to back a traditional line of credit. Although the SBA does not assign much collateral weight to A/R or inventory, getting them released may be a challenge.

Lastly, although EBITDA is strong at $2.5 million, if you have an SBA 7A loan for $5 million that would cost roughly $800,000 in debt service a year. Any lender doing a line of credit is going to stress the balance on that line. Assuming a $15 million line fully drawn at 8.50% (the Prime rate) that would be another $1.28 million in debt service. So your debt service coverage ratio would be low at 1.20x based on what lenders want to see. Even if you do not intend to fully use the line, I think all SBA lenders will underwrite the line as it if is fully drawn all year to be sure there is cash flow to support it.

I hope this information helps. Happy to discuss options, but it does look like it could be very challenging to finance.

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