When
business owners decide to sell their business, they should consider financing
the purchase — that is, offering “seller financing” — rather than selling the
business outright.
Consider
the experiences of two business owners whose companies had annual cash flows of
approximately $250,000 and were priced in the $750,000 range. The first
business was a distributor whose owners were asking for a $250,000 down payment
and the balance over the next eight years. The second was a light manufacturing
business whose owner wanted all cash upfront. The first business was able to
draw out a number of qualified buyers, received a few offers and, ultimately,
sold in a matter of months. The second hasn’t received any serious expressions
of interest.
When a
seller insists on all cash upfront, buyers see this as a lack of confidence in
the business, the buyer’s chance to succeed, or both.
The
primary reason that a seller shies away from offering terms is out of fear that
the buyer will be unsuccessful. A seller who feels this way needs to consider
the positives associated with seller financing. Many prospective buyers don’t
have the necessary capital or lender resources to pay cash; seller financing opens
the door to a bigger pool of buyers and creates a greater likelihood of
attracting a buyer who will be able to sustain the company’s success.
What’s
more, a seller offering terms will command a higher price. Buyers paying cash
will typically demand a discount. Another benefit is the interest earned on a
seller-financed deal is over and above the actual selling price. The distributor
who sold his business for $750,000 with a $250,000 down payment carrying for eight
years at 6% will net almost $900,000 during the term of the deal.
Plus, with
current interest rates as low as they are, sellers can get a much higher
interest rate from a buyer than they would receive from a financial
institution.
Obviously,
there are no guarantees the buyer will be successful in operating the business—which
can put the seller at risk of a buyer default however there are a number of
things a seller can do to protect themselves.
One of
the key protections for a seller is requiring the buyer to invest a significant
amount of their personal capital in the down payment. Nothing inspires a new
owner to succeed like the risk of a significant loss of their own money. It is
a lot harder to walk away from a $250,000 down payment than a $25,000 down
payment.
Another
often overlooked protection is knowing the buyer. This means more than having
some of the same interests or common friends. A seller should thoroughly review
the buyer’s credit history, personal financial situation and business
accomplishments. Other suggested protections include having an adequate
training period for the new owner, having a good client base and having strong
relationships with supplier, which can all help in securing the Seller’s note.
Finally,
secure the services of an experienced business broker to help you navigate
through these issues. A qualified facilitator can structure the transaction to
ensure that potential potholes are covered.
Selling a
business at a price that would make an owner happy is often a careful balance
between the risks of seller financing and the financial reward it brings.
Sellers may feel they got less from the sale then they wanted, while buyers may
feel they paid too much. Understanding the impact seller financing can play on
price along with ways to protect against the potential pitfalls will help
ensure a satisfying outcome.
Due to
the long hours, effort and risks associated with starting a business, and then
creating a thriving business, owners deserve to maximize their results when
selling it. Offering seller financing can help achieve this objective.
Do you have small
business questions you would like answered about this article or others? Please visit www.VRWindsor.com
or call 519-903-7807.
William Sivell is a
sales representative of VR Windsor Inc., Business Brokerage; his blog appears
every Tuesday.
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