Previous articles have discussed the importance of having a good reason for selling your business, getting the business ready for sale, setting the right asking price, and taking your business to market. In this article we will talk about the question of acquisition financing for your business buyer.
Whether you want to our not, you’re going to get involved to one degree or another in the financial arrangements of your buyer.
Acquisition financing is always an issue in selling a business. Almost all business buyers will need some amount of financing to complete the transaction. Of all the business sales that I’ve seen, over 90% involved financing of some description.
Very few business buyers are sitting on enough cash to buy a business without financing. People with that much money are usually “clipping coupons” and not interested in jumping into the challenges of daily business management.
So where do business buyers get the necessary financing? There are three sources, aside from family member of the buyer who sometimes enter the situation. Let’s discuss each:
Although most people seeking a loan to buy a business will think first of banks, I can tell you from years of business brokerage experience that banks generally do not make business acquisition loans.
That statement will surprise most people. Once you’re in business, banks will compete for your patronage, but most will not stick their necks out in the beginning to make you a business acquisition loan. Bank advertising would lead you to believe they would do so, but in more than 90% of the cases, they will find some reason to decline the business acquisition loan application.
The exception might be if you have a strong, years-long relationship with a bank and you can offer some other collateral such as Certificates of Deposits. Or if the bank participates in the SBA loan program, they might be able to approve a SBA guaranteed loan (see below).
So don’t be surprised if a bank turns down your buyer. And don’t take it as a reflection on your business or the buyer. It’s just the way things are.
Now this is the humorous part of the situation. It’s ironic but it has happened more than just a few times. After your business buyer been in business for a number of months or a year or so, the same bank that turned him down for a loan to buy the business may come calling on him soliciting his banking business. One of my buyers in this situation responded to the banker by assuming a serious air and in a somber tone, said, “Well now Mr. Banker, we’ll be happy to consider your application for our business. Let’s see, we’ll need your financial statement and a list of references and your business plan for five years into the future. Once we have your completed application, I’ll be glad to take it before my committee and let you know of our decision.”
The banker was taken aback.
The Small Business Administration (SBA), an agency of the federal government, provides for business acquisition loans through its approved lenders. The SBA generally does not make direct loans, but rather the agency partially guarantees the loan that is made by the approved lender. It’s known as the SBA 7(a) program.
The SBA list of approved lenders includes many banks with the largest lender currently being Wells Fargo. But some community banks also make a significant volume of SBA guaranteed loans. Some of these lenders will include in the loan total an amount for working capital in addition to the price of the business, after down payment. Down payment requirements range from 20% to 35% plus there are usually up-front fees paid by the buyer for various requirements. Interest rates are competitive with the marketplace.
Your business must be growing and profitable to be approved by the SBA. A downward trend in gross revenue or profits will usually disqualify a business. And another disqualifier of the SBA, is the requirement that the business buyer have experience in your industry. This requirement pretty severely limits the pool of prospective buyers for your business who can use SBA financing.
The SBA route for a business acquisition loan is sometimes frustrating because of the time, detail and documentation that are involved. If your buyer goes this route, be patient. And stay on top of the SBA requests for information. The quicker you can get the information and documentation to the SBA underwriter, the quicker your loan will close.
In the majority of the business transfers that I handle, the owner of the business finances a portion of the purchase price for the buyer. Some sellers are initially reluctant to offer financing. However, with a strong down payment from a buyer who has a good credit bureau report and personal financial statement, the advantages to a business seller can be significant.
Not only is the tax bite usually lower for a seller who finances, but national surveys consistently show that businesses with seller financing (1) sell for more money and (2) sell in a shorter time frame.
In one recent survey of 3,965 business sales as reported by Toby Tatum in Transaction Patterns, the median selling price of businesses with seller financing was 15 percent higher that those without it. The average down payment on seller-financed businesses was 37 percent.
And of course, there is the obvious benefit to the seller of additional income from the interest charged on the note. The going rate as this is being written is around 5 to 6 percent. This is significantly more than you could earn if you invested the money in a Certificate of Deposit.
And keep in mind, we’re not talking about you financing just anybody. We’re talking about a buyer whom you have approved after checking his credit report and references, and who has made a down payment of usually between 25% and 50% of the selling price of the business. Plus, you have a mortgage on the business and all it’s assets for the term of the note and the personal guarantee of the buyer.
Most owner financing – though not all — is in the form of a balloon note. The balloon note solves two opposing desires. The buyer of the business wants to keep his payments low; however, the seller usually wants his money as soon as possible. By amortizing the note – calculating the payments – on, say, a 12-year payback schedule, the payments are kept low. But the inclusion of a 5-year balloon requires that the remaining balance be paid off at the end of five years.
After the new owner has been in business for five years and has built a track record for himself at the bank, he should have no trouble going to his bank and refinancing the balloon. In the low interest rate environment of recent years, I’ve seen new owners refinancing the balloon even before it came due to save money. The balloon note has been a win-win vehicle for both buyers and sellers.
To recap, if you are willing to consider financing the sale of your business to a credit worthy buyer after an appropriate down payment, the advantages you can usually expect are:
- A lower tax on the proceeds of the sale.
- A higher selling price.
- A shorter timeframe to close the transaction.
- Additional income from the interest on the note.
In conclusion, please keep in mind that selling a business is not an overnight process. In my experience of over two decades as a business broker, about six to eight months is average.
He’re another article that might be of interest: Top 3 Issues Involved When Buying or Selling a Business.
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