Using the Target Company's Own Cash Flow to Help Fund Its Purchase in Ontario

Not every buyer purchasing an Ontario business has enough personal capital or hard collateral to secure the full purchase price. In many deals, part of the answer is structuring the financing so the business being purchased helps pay for itself — using its own projected earnings, rather than the buyer's personal balance sheet, as the main thing a lender or seller is relying on for repayment.

This is often called cash-flow-based financing (as opposed to asset-based lending), and it shows up throughout Ontario business acquisitions, from bank underwriting to vendor take-back terms to earn-outs. This article explains the concept, how lenders typically evaluate it, and where it tends to create friction.

Asset-Based Lending vs. Cash-Flow Lending

Most acquisition loans blend elements of both — a lender may register security against specific assets while also underwriting the loan primarily based on the target's historical and projected cash flow.

How a Lender Typically Assesses Cash Flow for This Purpose

• Historical financial statements, usually multiple years, to establish a track record rather than relying on a single strong (or weak) year
• Normalized earnings, adjusting for one-time items, owner compensation, and non-arm's-length expenses that wouldn't necessarily continue under new ownership
• Post-closing projections, reflecting the buyer's own plan for running the business, not just a straight-line continuation of the seller's numbers
• A quality of earnings review, often for larger deals, giving an independent look at whether reported profitability holds up under scrutiny

Because the lender is really underwriting the business, not just the buyer, a target's own financial disclosure and cooperation during due diligence directly affects how much financing is available.

Where Cash-Flow Reliance Shows Up in Deal Structure

1. Bank or other institutional debt sized to projected cash flow. The loan amount and repayment schedule are often set with reference to the business's expected ability to generate cash after closing, not just to the value of its hard assets.
2. Vendor take-back (VTB) repayment tied to the business's performance. A seller financing part of the price through a VTB is, in effect, agreeing to be repaid out of the business's future earnings under new ownership — which is one reason VTB terms are negotiated carefully and often subordinated to a senior lender.
3. Earn-outs. Part of the purchase price can be made contingent on the business hitting agreed financial targets after closing, directly tying seller proceeds to the target's actual post-closing cash flow.
4. Working capital adjustments. Purchase price is commonly adjusted at or shortly after closing by comparing an estimated closing statement of the business's working capital to a final post-closing figure — a mechanism that depends on accurately capturing the target's real financial position at the moment of transition.

The Risk in Relying on Future Cash Flow

Financing an acquisition primarily against future performance shifts real risk onto whoever is being repaid that way — commonly the seller (through a VTB or earn-out) or a subordinated lender. If the business underperforms after closing, for reasons that may or may not be within the buyer's control, repayment can be strained. This is a significant reason:

• Sellers negotiate security (often a PPSA registration) for VTB amounts rather than relying purely on trust in future performance
• Earn-out provisions are drafted carefully to define exactly how post-closing performance will be measured, and who controls the business's operations during the earn-out period
• Senior lenders often require minimum buyer equity and impose ongoing covenants, precisely because they are also relying on projected cash flow rather than liquidation value alone

Frequently asked questions