Updated April 8, 2022
As a business broker with offices in Fairhope, Alabama and Baton Rouge, Louisiana, I’m often asked what the top critical issues are in buying or selling a business. If the top three issues discussed below in the sale or purchase of a business are not properly addressed, then there is a good chance the transaction will fail.
So to get to the core of the question, these are in my opinion the top three issues involved in buying or selling a business:
Critical Issue #1: Confidentiality
Confidentiality is critical to the successful transfer of a business. If word gets out that a business is for sale, several things start happening and none of them are good for the seller or buyer of the business. First, key employees start looking for other jobs, fearing that a new owner may not retain them. In the uncertainty, customers may begin shopping elsewhere. Suppliers get nervous. Competitors can take advantage of the situation.
This is why a prospective business buyer will be asked to sign a non-disclosure confidentiality agreement early in the process of looking at a possible business acquisition. In this agreement, the potential buyer confirms that he/she will not disclose the fact that the business is for sale except to professional advisors.
If you show that you take the need for confidentiality seriously, you will be regarded as the professional that you are.
Critical Issue #2: Valuation
Nothing causes the buyers and sellers of businesses more anxiety than the issue of valuation. The question of selling price haunts both parties. The seller doesn’t want to price his business too low and “leave money on the table.” On the other hand, the buyer of the business is afraid he’ll pay too much and not get the best possible price.
Formal, fully documented business appraisals are now readily available. In addition, there are rules of thumb guidelines that can be used to quickly estimate the value of a business. As just one example, we know that a full-service restaurant with a liquor license is worth about 30% of its annual gross revenue as an ongoing business. This assumes – big assumption – that the business is earning the average bottom line profit for its peer group.
There are rules of thumb guidelines for almost all categories of business from ice cream stands to manufacturing plants. But again, these guidelines provide only quick estimates. And written, fully documented business appraisals are now done by several respected national firms at a cost similar to real estate appraisals.
Critical Issue #3: Financing
Financing is always a concern, as hardly any business buyer has the financial capacity to write a check for the purchase price of a business. If they did, they would most likely be living off of investment income rather than buying a business.
These are five possible sources for business acquisition loans:
BANKS – Although most people seeking a loan to buy a business will think first of a traditional bank loan, I can tell you from years of business brokerage experience that banks generally do not make business acquisition loans. There are exceptions but they’re rare.
SBA – The SBA, through its approved lenders, provides business acquisition loans. The SBA does not make direct loans, but rather guarantees a portion of the loan that is made by the approved lender. It’s known as the SBA 7(a) program. Wells Fargo Bank is currently the top volume SBA lender nationally.
The SBA route for a business acquisition loan is sometimes frustrating because of the time and detail that is involved. However, keep in mind that the SBA will approve loans that others have turned down and will usually approve them with a smaller down payment. In most cases, it’s worth the wait.
FAMILY – Many times the older generation in a family will loan the down payment or the entire amount needed to a promising member of the family’s younger generation. If your family is willing to loan you the money, one word of advice is in order. Have a very clear understanding as to how the debt is to be handled and put it in writing in the form of a legal note.
THE SELLER – In a significant percentage of the business transfers that I handle as a business broker, the owner of the business finances a portion of the purchase price for the buyer. Some sellers cannot offer owner financing for a variety of reasons, but when they can, it conveniently solves the problem of financing.
The fact that the business owner is willing to finance the sale of his company provides more than a convenient finance plan. More importantly, it provides strong validation of the owner’s belief that the business will support the owner and earn enough cash to pay back the loan. You can’t get any better recommendation on the business than this.
The normal down payment for owner financing ranges generally from around 30% to 50% of the purchase price of the business. Interest rates are generally market-driven but there is more flexibility here than in other forms of financing.
401(K) FUNDS AND IRA ACCOUNTS – The use of these funds to buy a business, without tax penalty, is a fairly recent development. Several national CPA and attorney groups have developed a plan, approved by the IRS, which allows you to use your funds for business acquisition. There are legal and accounting fees involved, but they are a small fraction of the tax penalty that would be assessed for cashing in these accounts early.
The above five sources of financing are not exclusive to each other. I recently handled a transaction in which three of the five sources were used to buy the business.
It’s called creativity!
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If I can assist you with any considerations involved in the valuation and transfer of ownership, please don’t hesitate to email or call me.
For further reading, here are additional related articles:
- How to Use Valuation Guidelines to Estimate the Value of a Business
- What are the “Discretionary Earnings” of a Business?
- How to Analyze a Business You’re Considering Buying
- How to Make a Written CONTINGENT Offer to Buy a Business
- Seven Negotiating Rules When Buying or Selling a Business
- How to Conduct Due Diligence When Buying a Business