Financing the Sale of your Business
When the time arrives to transition your business to new owners, the first step is for you and your advisors to arrive at a price which both meets your expectations and will be accepted by prospective buyers. Step two is a frank discussion about how potential buyers might receive necessary bank financing to consummate the purchase of your business.
Most long-time business owners are surprised to learn that since the Great Recession commercial banks have morphed into asset-based lenders. Long gone are loans based on handshakes, your integrity and presence in the community, and/or bankers’ knowledge of the success of your business. Banks will only loan against assets and then only on a percentage of the appraised value (as established by independent appraisers) of the assets. A business buyer is now required to get a business valuation, real estate appraisal, machinery and equipment appraisal, and an environmental assessment (even if the business facility is only being leased). It doesn’t matter what you or the buyer thinks the values are, banks will only loan based on third-party independent appraisals. In most cases, buyers’ cash plus the limited nature of bank financing is inadequate to buy your business for your expected price. There are two often-used remedies to close the gap between buyer/bank cash and seller expectations: (1) SBA financing and (2) seller paper. (We will discuss seller paper now, while addressing SBA financing next month.)
Seller paper (also called a seller note) is the same concept as a land contract on real estate. You finance a portion of the business purchase price in order to accomplish the sale. While the motive is excellent (i.e., the use of a seller note to close the gap between the sell price of your business and the combination of buyer cash and bank financing), seller paper is now expected by most buyers and banks. And, unfortunately for the seller, banks demand that the seller note (which is usually unsecured) be subordinated to current (and future) bank loans. Banks also have the power to tell buyers to suspend seller note payments if banks feel that payments on the bank loan might be in jeopardy.
The punchline is that in most business sales the seller will not get entirely cashed out at closing. Like it or not, you should prepare mentally and financially to carry between 10% and 35% of the sale price in a seller note. There are, however, a couple of positive aspects of seller paper: the larger a seller note you are willing to carry, the higher the selling price and the faster the sale..
Contributed by Michael Greengard, Praxis Business Brokers.