Resource

Six steps to social acquisition

May 6th, 2024

A social acquisition is the process by which a conventional enterprise is acquired and restructured into a social enterprise or other form of social purpose organization.

This literature review on social acquisitions from Scale Collaborative shares more information. They explore the potential for social acquisition to solve problems in our economy, saying:

“What if non-profits could acquire existing businesses at risk of closure due to a lack of viable succession plan and convert them to social enterprise? We believe there is an opportunity for the small business and non-profit sectors to solve each other’s problems. This pathway to creating a social enterprise has the potential of addressing the small business succession problem and helping non-profits to leapfrog the risky start-up phase at the same time.”

Transitions of Small Business to Non-Profit and Community Ownership: A Literature Review, p. 1

The following is a step-by step breakdown of social acquisition from Carla Leon, President and CEO of Just Like Family Home Care. When she had to opportunity to join the Just Like Family Home Care team, Carla spearheaded the first social acquisition by charities in Canada. Carla is a co-author of Win-Win Capitalism: How Social Acquisitions Will Change the Face of Business.

Step One: The Letter of Intent (LOI)

The Letter of Intent (the LOI) process is straightforward. Don’t allow this part to hold you back.

An LOI is your formal intention to proceed on investigating a business deal. It is a mutual understanding between the buyer and the seller that you are going to begin sharing information and formally going down the path of a future deal. LOIs can be for anything, including a potential merger   or acquisition.  But they can also be for strategic partnerships, joint ventures, or any business agreement that requires due diligence in advance of moving forward.

Typically, an LOI includes general terms of what is being investigated, a confidentiality clause, and the time in which the investigation will occur. There is usually something about costs and who incurs them if things don’t progress, and some of them have a proposed next step if things do progress.

The moral of the story is to sign the LOI and get moving on the next steps.

Step Two: Due Diligence

No one is going to invest in something that they don’t understand! Due diligence is necessary when doing any business deal. This is even more true with charities as your investors. Boards that run charities are much more risk-averse than an individual investor might be.

Find someone to support your due diligence who is a credible resource.

Step Three: Business Planning & Pitching

Unlike individual investors who might ask for specific financial ratios, charities are completely different as they often have multiple stakeholders with multiple lenses that are going to give them insight into whether they should invest or not. Recognizing the internal decision-making structures of charities, their boards, and management, you have to move quickly to set up preliminary presentations and get information into the decision makers’ hands.

Fundraising for a charity works similarly to fundraising to buy a business. Most charitable goals are halfway or more met prior to a large public campaign or a gala. This is because you start with the larger donors prior to having the gala. Fundraising to purchase a business is similar. People want to be part of something that seems like it will be successful. They want to invest in something that other people have already confirmed is a good idea.

You need financial proformas, non-disclosure agreements (NDAs), and pitch decks.  Create a sensitivity analysis, an NPV  to support valuation, and a full business plan. Create a huge list of over 100 investors. Reach out to every one of them within the first week by email and phone. It is the 10% rule – only 10% of people will sign the NDA and only 10% of those will invest.

Step Four: Financing

In all businesses there is a balance between equity and debt.

Equity is invested cash that is paying for shares  and ownership of a corporation.  If an individual was to create a corporation, they might issue one share that is owned by the individual in order for them to own the entire company. When you have more than a single owner or investor in a corporation, you need to issue more shares and divide these shares amongst the owners based on the ownership structure. People are more familiar with buying stocks (which is another name for shares) in large companies through the stock exchange or part of a mutual fund that they or their financial planner has selected. To protect people from scams and crooks, most governments worldwide require someone to be an experienced investor in order to do direct equity investment in something that is arm’s length. This type of investor is called an accredited investor.

An accredited investor means that you can only offer shares in Canada to charities with more than $150,000 of investments, individuals with more than $1M in assets, or individuals who knew the directors of the company firsthand.  When you have this commitment, everyone still must sign an additional release that they fully understood that they are getting themselves into and that this was a highly risky investment.

Debt is a loan. This is used in finance so that people that invest equity into a business own a larger percentage of the business than they would otherwise. For instance, let’s say you wanted to buy a $1M business and you bought it all with equity. If your profit was $250,000, then the return on your investment would be twenty-five percent. Let’s say that instead of buying it with $1M of equity, you used debt to finance half of the purchase, so $500,000 is equity and $500,000 is debt. The same profit of $250,000 would give you a fifty percent return on your equity instead of the twenty-five percent return. By using debt, you can get a higher return on your equity, which is called leveraging debt. 

So why is debt appealing to impact investors? Debt is paid back first, prior to any dividends being paid to shareholders. Lenders have a guaranteed return at whatever the interest rate is, but they don’t get to participate in the upside if the business does well.

A common way for a business to acquire debt is through a financial institution.  However, it can take 90 to 120 days to complete the financial institution’s paperwork and be approved via the credit department. Typically, these institutions require that the loan is personally guaranteed or has some other sort of collateral.

Financial institutions won’t accept a charity’s guarantee, as a guarantee is only good if the lender is willing to collect on it. No financial institution wants to be the one to shut down a charity by collecting on a guarantee.  In essence, a charity’s guarantee on debt becomes useless. So, private lenders are usually the best form of debt for a social acquisition. Unless you find another organization or individual to issue a guarantee on your behalf.

Step Five: Structuring

Unsurprisingly, structuring has quite a few pieces that need to be patched together.

First, how is the equity going to be structured? Founders’ shares acknowledge the work that was done prior to acquiring or incorporating a business, and have a lower purchasing cost based on this previous work.  The remaining investors are awarded common shares  with equal voting rights. Often there are multiple classes of shares including preferred shares.

Next it is time to incorporate. Only once the shares are delineated and agreed upon can you incorporate, as the information regarding the number of shares and type of shares is required in your incorporation documentation and your Central Securities Registry. This is when you declare who owns which shares and support that all investors are accredited and you have stayed on the right side of the legal line.

All accredited investors are provided a shareholder agreement  and a subscription agreement,  and they need to sign off on how and why they are an accredited investor.

Step Six: Closing the Deal

Like everything else in a social acquisition, closing doesn’t just happen. There are stages and components of this process. The key is keeping the communication open and building trust.

During the term of the LOI (the time period that you had in the LOI to do all of the pieces before agreeing to move forward), you should have finalized what the next steps are in the purchase, which includes the purchase agreement. This can be either a share purchase agreement or an asset sale agreement. 

Once you are both clear on the terms, the price and payment of the transaction, and you are comfortable with everything learned through due diligence, then you waive your conditions. Conditions can include financing, due diligence, and really anything else that you are concerned about that could be a valid reason for the share purchase agreement to be invalidated.

Other agreements that are prepared for the close are the transitions agreement,  the non-compete,  and any releases.

Once conditions are waived, you are stuck with the deal. So, you better be darn sure that you have your ducks in a row. At this point there could be some serious legal repercussions.

And that’s how you do a social acquisition!

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