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Step
4 - Structure & Negotiate The Sale
Seller
Financing: 9 Ways Protect Yourself
1.)
Check The Buyer's Background - It may sound obvious, but
when it comes to getting paid the money the buyer owes you,
the most important thing you can do is verify that the buyer
is qualified.
Too
many sellers - in their rush to sell ASAP - ignore warning signs
the buyer send throughout the selling process.
In
the next section we will discuss Due Diligence. While most people
associate due diligence with the buyer investigating the seller,
in the next section we will talk about what you can do to investigate
the buyer's financial qualifications as well.
But,
in addition to checking the credit reports, personal assets,
work experience and personal references of the buyer you should
also be assessing the buyer on a personal and professional level.
Don't
be afraid to interview the prospect early on in the selling
process just as you would a job candidate.
Usually,
the more qualified and prepared the buyer is, the more understanding
they are of you concerns. Conversely, the buyer who is lying
about past businesses successes or their financial capabilities
will balk at any attempt to get to facts.
Here
are some warning signs that buyers often give when they are
looking at your business. If more than 2 or 3 of these apply
to your buyer he may not be the type of person you want to lend
money to:
*
They delay or avoid any discussion of their financial qualifications.
*They
seem more interested in how much money you will take off your
asking price than they are in the actual operations of the business.
*They
expect/demand all sorts of financial information from you up
front without providing any proof they can actually afford the
business. In other words, they want the flow of information
to be all one way.
*They
are very forthcoming with financial information about themselves
and it is bad (or inadequate to buy your business)
*They
have bought or started more than one business in the past that
failed.
*They
are undercapitalized. As we stated previously, buyers tend to
underestimate how much money they will need. If they have just
enough cash to cover the down payment then they are undercapitalized.
*Lack
of experience. If they never ask any insightful questions and
never raise any concerns/objections it's probably not because
your business is perfect but because they don't know what to
ask.
2.)
Don't Give The Buyer A Legal Excuse To Not Pay You - Some
short sighted sellers try to hide certain negative aspects about
their business thinking that once the business is sold they
are off the hook. From a legal standpoint that may not be the
case.
Always
be forthright with the buyer.
The
Sales Contract will includes a section for Representations and
Warranties - statements of fact about the business such as:
*All
the financial information provided to the buyer is correct
*The
seller owns the assets listed in the sales agreement
*All
tax returns have been filed and there are no taxes owed unless
specifically listed
*All
liens and encumbrances have been listed
These
and many others statements can be part of the sales agreement.
Of course
your lawyer will help you with this. Always be honest with your
lawyer about any problems with the business - they can't protect
you from legal problems if the don't know the true state of
the business.
Avoid
making any promises or guarantees about the business' future
performance or the health of the industry. Once you sell you
can't control these things anyway.
3.)
Make Sure The Payment Terms Are Realistic - In our discussion
of Financing
Basics we discussed the need to limit the length of
the repayment period. It may be tempting to try to squeeze every
last dime out of the buyer and then shorten the repayment period
to 12-18 months. But if the result is that the buyer can't meet
his monthly payment obligations then you haven't done yourself
any favors.
Remember,
the buyer will be paying himself and you out of the cash the
business generates. The financing plan has to be based on realistic
expectations about the business' performance in the near future.
Just
as buyers tend to underestimate how much cash it will take to
get into the business, they tend to overestimate how quickly
they can increase profits. In truth most businesses experience
lower sales and profits immediately after the new owner takes
over.
You
know your business better than anyone, so don't let an overly
optimistic buyer tempt you into a unrealistically short payoff
period - better to wait 5 years to receive all you money and
actually receive it than to set up a plan where the buyer starts
missing payments almost immediately.
4.)Life
insurance - You can have the buyer take out a life insurance
policy with yourself as beneficiary.
5.)
Acceleration Clause - An acceleration clause states that
if a buyer fails to make a payment on time, the entire balance
becomes due immediately.
6.)Additional
Collateral - If the buyer has a personal residence with
significant equity, commercial real estate or other investments,
you should ask him to put them up as collateral.
7.)Personal
Guarantee - Just like a bank, you can require the buyer
to personally guarantee the loan when you sell your business.
You should also get a personal guarantee from the buyer's spouse.
This prevents the seller from transferring all their assets
the spouse in order to avoid paying you.
8.)Sales
Contract - Depending on the circumstances when you sell,
you may want to restrict the new owner's acquisitions, expansions
and sale of assets until you are paid in full.
9.)
Escrow - If you are selling a corporation or LLC, you and
the buyer may agree that your corporate stock of LLC certificates
will be held by a third party - such as an escrow agent - until
the buyer has paid you in full. If the buyer doesn't make good
on his payments the escrow agent would then return the stock
certificates to you.
NEXT:
How
To Use Seller Financing To Negotiate A Better Deal
