Financing
The Sale Of Your Business
While
every seller dreams of getting that one big payday, the reality
is that most small business sales (about 80% according
to most estimates) involve some type of seller financing.
Yet,
in a review of all the businesses we listed for sale at TheBizSeller.com
in 2007, only 25% of sellers initially offered some
type of seller financing.
As
odd as it may sound, there are actually some benefits
to providing seller financing instead of an all cash deal.
First,
by spreading out payments over time you will usually lower
your tax rate.
Second,
and most importantly, you will exponentially increase
the size of the pool of qualified buyers. Most buyers
don't have the cash to cover the full price and contrary to
popular belief, banks are not lined up waiting to give money
to new business owners.
Here
are some guidelines when it comes to seller financing:
1.)
Get a down payment of at least 30% but shoot for 50%
- 60%
The
first reason you want as big a down payment as possible is
obvious: the more the buyer puts down, the more they have
at risk in the purchase and the harder they will work
to make it a success.
The
buyer will be making monthly payments to you out of the cash
flow the business generates. So the payments must be low
enough that the buyer can pay himself a decent wage and
have enough left over to pay you. The down payment, therefore
must be big enough to lower the monthly payments into
this affordable range.
Even
if you do not need a lot of money up front to live on and
want to spread the payments out to lower your taxes, you will
still want a sizable down payment to cover your expenses
related to the sale itself. Consider these expenses that
you will face after selling:
Taxes - sales tax, stock transfer tax, real estate
stamp tax, and other taxes due at the time of the transaction.
Loans - you'll need enough after tax cash to payoff
those business loans not assumed by your buyer.
Fees - appraiser, attorney and accountant's fees, and
in some cases broker's commissions.
Word
Of Warning: Most buyers overestimate how much they
can afford to pay down.
Many
buyers will look at how much money they have in the bank and
think this is what they have available for a down payment.
But
just as you will have legal and accounting expenses associated
with the sale, so will the buyer. Then there are the living
and operating expenses the buyer will need in reserve when
they first take over the business. It's common for
a business to experience reduced sales and profits
in the months immediately after a new owner takes over.
An
over anxious buyer may very easily underestimate how much
money they will need in those first few months.
While
this is technically "their problem", it can have
serious consequences for you when it comes to receiving
timely payments each month.
So
make sure that the down payment is big enough to put the remaining
payments in a range the business can support but not so big
that the buyer is cash strapped the day they take over.
Along
these same lines: you should know where the buyer is getting
their down payment from. You may feel secure in the
knowledge that the buyer has paid you 60% down, leaving only
40% to be covered by future payments.
But
if they borrowed that 60% down payment from their rich uncle
they have actually financed 100% and the chances they can
meet monthly payments on both loans in unlikely.
2.)
Limit the repayment term to 3-5 years
Your
goal in setting up the financing should be to lower your
risk as much as possible. The longer you stretch out the
repayment period, the greater the chance that something will
go wrong and you won't get fully paid. Obliviously, the greatest
threat to your payments is that the buyer may run the
business into the ground.
Also,
economic conditions can change and, through no fault
of the buyer, the business is no longer generating as much
profits as in the past.
3.)
Always Charge Interest
Earlier I stated that only 25% of the businesses that listed
here at TheBizSeller.com in 2007 offered any type of
seller financing. Yet of those that do, a surprising number
of these sellers were willing to not only finance the sale
of their business but to do it interest free!
There
are several reasons why this is a bad idea.
First
of all, offering 0% financing is just giving away money! Buyers
expect to pay interest on the money they
borrow.
If you sell your business for $200,000 with $100,000 down
and finance the remaining $100,000 for 5 years at 8% interest
you will make $21,162 in interest. There is no reason
to give that away.
The
buyer may try to negotiate with you to get a better rate but
they are still prepared to pay something.
Which
brings us to the second reason you should always charge interest
on the money you loan - it gives you flexibility in
negotiating. You can always lower your interest rate
(Which is preferable to lowering the price) as part of the
negotiation's give and take. But if you offer no interest
up front it gives you nothing to offer during negotiations
because you have already given it away.
And
the last reason you should always charge interest is that
the IRS may tax you as if you did collect interest .....
even if you didn't. It's called "Imputed Earnings"
and it allows the IRS to estimate the amount of money you
would have earned if you had changed a fair rate of interest
and then tax you on those earnings.
As
we stated earlier: you should set up the financing to make
your risk as low as possible. So next we will discuss the
different ways you can protect yourself and increase
your chance of getting paid all that you are owed.
