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 suppliers, 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.
Bill Sivell is a salesperson with VR Windsor Inc., which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. He blogs about business sale at Maxbizvalue.blogspot.ca.
More columns by Bill Sivell