Should You Help Finance the Purchase of Your Business?
Seller financing is one way to help assure that the business will sell. Offering to help finance the purchase of your business can make your business much more attractive to potential buyers. You will save them the hassle of obtaining financing on their own, plus you will interest buyers who may not be able to get financing through traditional channels.
Should you and the buyer elect to take this route the terms of the financing contract will be based on your need to sell and on how much financing the buyer requires. This will depend in part on how much the buyer has for a down payment.
From the perspective of the buyer, securing financing through the seller is easier and gives the buyer greater flexibility than working with a traditional lender. For one thing, the interest rate will generally be lower than a bank loan. The payment schedule can also be more flexible. Since the buyer and the seller are both working toward the same end result, it is in the interest of both parties to create a suitable financing and payment plan.
The advantage of such financing for you, as the seller, is that you can usually get a higher price for the business than if the buyer is working solely with other financing sources, such as a bank. Outside lenders may not want to take on the risk, and may limit the amount of the loan.
Of course as the seller and the lender, you are assuming risk too. Your due diligence should include checking the credit rating of the buyer, as well as a thorough inquiry into the buyer’s background.
As a seller, you should know why the buyer is purchasing the business, and you need to be confident in the buyer’s ability to make regular payments. In most seller-financed situations, the business itself is the collateral. This is only worthwhile if the business is doing well. If not, you may need additional collateral.
Your specific situation and your buyer’s circumstances will both influence how the deal is structured. For example, if you are selling because you need money immediately, you won’t be able to finance the sale. But if you are in a position to receive payment over time and are comfortable with the buyer’s credit history, then such financing can be advantageous.
It’s not uncommon for the seller to finance 40 to 50 percent of the purchase price of a business. In addition to the financing, any number of terms can be factored into such an agreement. For example, the contract might specify that you stay on as a consultant or in some similar capacity, receiving a salary through the transitional period and for several months or even a year or more after the deal has been completed.
As a seller, you should know why the buyer is purchasing the business, and you need to be confident in the buyer’s ability to make regular payments. In most seller-financed situations, the business itself is the collateral. This is only worthwhile if the business is doing well. If not, you may need additional collateral.
Your specific situation and your buyer’s circumstances will both influence how the deal is structured. For example, if you are selling because you need money immediately, you won’t be able to finance the sale. But if you are in a position to receive payment over time and are comfortable with the buyer’s credit history, then such financing can be advantageous.
Preparing to Sell Your Business
The completion of a sale can take over a year, so keep that in mind as you plan your exit strategy. Here are several basic steps you should take to ensure that your business is ready:
1. Get a business valuation. One of the first things you should do is obtain a realistic idea of what your business is worth from an objective, outside source. A professional valuation will give you a basis for gauging buyer offers and will give you an idea of what you can expect to net from the sale. It will also tell you your business’s market position, financial situation, strengths and weaknesses (which you can hopefully correct prior to putting it on the market).
Valuations can be obtained from a number of sources, ranging from local accounting firms to regional business brokers and investment banking firms. As a rule, you should make sure the company performing your valuation has access to the most current national data regarding privately held transactions in your industry. Experience in selling firms of your type is obviously helpful as well.
2. Get your books in order. Buyers evaluating your business generally require at least three years’ worth of financial information. The more formal your statements (accountant-reviewed or -prepared vs. internally generated statements), the better the impression you’ll make-and the easier the due diligence for a buyer. Tax returns may suffice.
3. Understand the true profitability of your business. Most privately held businesses claim a variety of non-operational expenses. Make sure you have supporting documentation for these expenses. For example, your business may be paying for your personal automobile lease.
In addition, there may be infrequent expenses you have incurred during the past three years that should be excluded in a buyer’s analysis of recurring cash flow. There may be moving expenses if you’ve moved to a larger facility or unusual legal expenses.
4. Consult your financial advisor. It’s wise to speak to your tax advisor for help planning your financial future. Understanding your personal and corporate tax situation may also help you recognize your options with regard to deal structure.
5. Make a good first impression. Will a buyer visiting your shop for the first time see order or chaos? Buyers look for companies that show well, as an orderly shop is often indicative of an orderly management team and back-room operations.
6. Organize your legal paperwork. Review your incorporation papers, permits, licensing agreements, leases, customer and vendor contracts, etc. Make sure you have them readily available, current and in order.
7. Consider management succession. If you’re absolutely vital to your business, who will a buyer be able to turn to for help running the business after you leave? You should have a succession plan in place before going to market.
8. Know your reason for selling. Buyers are always curious as to why a seller wants to exit a business. (If it’s so great, why are you leaving?) Be prepared to articulate your reasons.
9. Get your advisory team in place. Start interviewing attorneys and accountants who are proficient in mergers and acquisitions. Strongly consider hiring an intermediary, either a business broker or an investment banker, to represent you and help you through the selling process.
10. Keep your eye on the ball. Don’t let your business performance decline because you’re too focused on the sale of your business. This will only give buyers additional negotiating power to lower their offers.
A Business Seller’s Major Concerns
For many owners, selling their business is a new experience, and there is always the fear of the unknown. Selling a business is a not only a major economic decision but also can be an emotional one. After all, many business owners have spent many years, and a lot of hard work building the business. When the decision to sell is made, there will inevitably be accompanying concerns. However, when faced head-on these concerns can usually be addressed and resolved. Here are some of the major concerns and ideas on how to deal with them.
Getting the Highest Possible Price
Every seller wants to get the highest possible price for their business – that’s a given. Here is an old, but very accurate definition:
The Asking Price is what the seller wants.
The Selling Price is what the seller gets.
The Fair Market Value is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.
Today’s buyers are more educated, more sophisticated, and more demanding than ever before. They seem to be searching for a “sure thing” – yet, many are afraid to make the leap-of-faith necessary to make the final plunge. Buyers are also more numbers conscious than in prior years. Somehow they think they can buy a business and continue with business as usual.
Sellers, on the other hand, must understand that the buyer may buy with an eye to the future, but is only willing to pay for the past performance of the business. The buyers believe that the future of a business is up to them and they should reap the benefits of their efforts. The value or price, however, in their minds, is based on what the seller has done with it.
In order to obtain the highest possible price, the seller should make sure that the financial records are crystal clear. Any issues, whether, financial, operational, legal, or environmental should be addressed and resolved prior to putting the business on the market. Hidden issues will harm sales than anything else.
This may seem a contradiction, but the seller must go to market initially with a fair price. Too many times, a seller’s first inclination is to start with a very high – and – unreasonable price. They may feel that the business is really worth what they are asking and may be unwilling to accept the fact that the price is unreasonable. The thinking is that an interested buyer can always make an offer. Interested buyers will feel that the price is so high that a fair offer would not even be considered.
Seller Financing
Another important factor relating to the asking price is the amount of cash involved in the sale. There is an old saying that the higher the full-price, the lower the down payment – and vice-versa. The sale of almost any business involves some seller financing. The smaller the down payment, the higher likelihood of a quick sale. No seller wants to take his or her business back because the buyer wasn’t successful. On the other hand, a buyer wants to make sure that the business will not only pay for itself, but also provide sufficient income for his or her family’s needs.
What it all boils down to is that the seller wants the buyer to be successful and the buyer wants to buy a successful business. With the amount of capital required in today’s market to buy a business, sellers should feel optimistic that they are dealing with successful buyers.
Maintaining Confidentiality
Confidentiality is always a major concern. Sellers feel that maintaining confidentiality is important in safeguarding the current business. They don’t want the word to leak out to customers, suppliers, competitors – and especially the employees. This is an area where a business broker professional can especially help. They use non-specific descriptions, screen and qualify buyers and require buyers to sign confidentiality agreements before showing businesses or providing specific information.
However, even under the best of circumstances, rumors can fly. There are basically two ways to muffle the business-for-sale problem. The first is to explain that over the years there have been people who have inquired about whether the business might be for sale. These inquiries are unavoidable and they do happen.
The way other is to handle the matter directly and to explain that you have been considering retiring and now may be the right time. The employees, especially the key ones, should be told prior to putting the business on the market so they don’t hear the rumors second-hand. They should be told that they are a very important to the business’s success and that a new owner would most likely be happy to retain them. When the sale is complete, they can be offered a bonus for helping in the process. Sellers should do whatever it takes to keep the employees from deserting the ship and on deck to maintain business as usual. Once employees have been dealt with openly and fairly, they will understand that discretion will help protect their future.
The Future of the Business
Sellers may feel that they have built the platform for the future growth of the business. It is only natural for them to want to share in any extraordinary profits in what they feel they have helped create. Sometimes, if the price is low enough and it allows a buyer to purchase the business, he or she may be willing to provide some type of earn-out or royalty based on any substantial increase in sales. The professional business broker can offer advice on how to make this work for everyone. However, everyone has to agree that no one can predict the future. As mentioned earlier, the buyer is hoping to buy the future, but is not willing to pay for it.