Deciding whether your business sale should be a cash sale financed by a bank or seller financed (or even some variation between those) is an important step in the process of preparing for sale. Odds are that if you are planning on selling your business, you picture yourself receiving a very large cashier’s check or wire transfer in exchange for handing over the keys to your business, and then each of you – seller and buyer – then go your separate ways.
In our everyday lives, when we sell something, we typically wash our hands of it and walk away, money in hand. Even when you sell a house, typically you’ve moved on to something bigger and better and aren’t looking in your rearview mirror as you pull away. Such is not the case with seller financing a business, and for the uninitiated this can seem like a mighty big note to hold on to.
While I can certainly understand this concern of “I don’t want to be the bank,” you should be aware of at least three ways that holding the note on part of the purchase price of your company benefits YOU, the seller:
- You get a higher price for the business;
- You get a higher return on your investment after the sale; and
- You’ll get a quicker sale.
Get a Higher Price for Your Business
According to numerous independent analyses of sold businesses across a wide variety of industries, you can actually expect to get more for your business when offering seller financing. Toby Tatum reported in his book Transaction Patterns that with seller financing, sellers actually received 25% to 30% more for their businesses when he compared the sale prices of 2,703 cash deals and 1,262 deals that were seller financed. This is not just anecdotal evidence. I have seen it in my own practice and hear the same reports from colleagues in the industry.
Candidly, no matter if you are selling your business to a Private equity Group or a strategic buyer even a high net worth buyer…. You will be asked to finance at least a portion of the purchase price. SBA in 2009 make it mandatory for the seller to finance a portion of the purchase price unless there is some unique circumstances. Certainly I am not talking about the outliers here. In addition, Private equity more than they don’t require some type of financing. YES I have seen it before be pretty low percentage… But the requirement still remains. When I say requirement. It is required in order for the buyer to feel comfortable buying your business over another one on the market.
You Get a Higher Return on Your Investment
When you fulfill 100% of the role of the bank, you have a great opportunity to earn far more money than with just the initial sale with The Power of Interest.
A basic understanding of how banks make money with interest will show you what I call “the power of interest.” When you take advantage of the opportunity to finance your business at 8% to 10%, you make what starts out as a good sale into a fantastic investment.
Here’s an example. If you finance $250,000 for a period of five years at 8%, you will receive an extra $54,145 on the note; financed at 10%, you will get an extra $68,705. There are few investments available these days that can reap that kind of return.
Don’t forget that statistically you receive 30% more for the business by financing it rather than selling it for all cash; therefore, on an all-cash deal this note would be extra $192,307 to invest somewhere else. Therefore, to earn the same money on an all-cash deal as you would in a seller-financed deal, you will need to earn between 20% and 23% on your money. WOW! Where are you going to get that kind of payout? Real estate investments? Stocks?
Why not consider the VERY realistic to realize an 6% to 10% return on your investment when financing the sale of your own business. This is a great reason to be a financier of your business sale, especially in a rough economy times.
Get a quicker sale
If the above reasons weren’t quite enough to “sell” you on the prospect of seller financing, here’s one more reason to consider — seller financing can also lead to a speedier sale. If the seller plays the role of the bank (where a bank isn’t involved at all), then the deal gets done more quickly (from saving time with the banking process to decreasing the sales process time because of increased buyer confidence). Applying for a bank loan takes a long time and is a meticulous process for both the seller and the buyer.
Banks simply will not loan money on a lot of quality businesses. Banks are asset lenders. They want to loan money on the actual tangible assets of the business. They don’t know you, they don’t know how great your business is. By focusing on tangible assets, the bank has a quantifiable way to feel comfortable loaning the money, to make the loan look good on paper. Banks look for the SBA (small business administration) to guarantee the loans that go above the value of the assets.
However, with recent law changes even the SBA now limits the amount of money that it will allow the bank to lend. This is important to you as the seller because most buyers look to the bank to help in the purchase.
When a bank says that they will lend money only on the assets of the business, where does that leave the buyer? Because the bank takes this approach, the buyer feels that the business is only worth asset value; and as you and I both know, many times the value of your company is located in the “goodwill” or “going concern,” and the assets are just one component in a long list of valuable characteristics of your business.
It is important for you to play the role of the bank because it is becoming more and more difficult to get ANY business financed for a sale, much less a business that has (any conceivable kind of) a blemish associated with it.
In addition to the fact that it is difficult to get the business financed, banks move much slower than sellers, even when they do approve a loan. Banks take anywhere from 90 to 180 days to approve – and close – a loan.
Another downside of outside banks
Not only banks slow, the bank’s approach to value may minimize the perception of value in the eyes of the buyer. From my experience, even when a bank does approve a loan, bankers sometimes give the buyer negative feedback about the business, inducing the the buyer to back out. I know this sounds outrageous, but you would be surprised how many times that has happened just in my firm.
Seller financing provides confidence to buyers that you, in fact, have a good business, and staking your own money on that assurance. If you didn’t have a good business, then why would you offer a structured sale? It is one thing to say you have a good business and ask the buyer to put their life savings into your company to prove it, but is quite another thing for you to tell the buyer that you believe in the business enough that you will offer terms on the purchase.
Scot Cockroft is the Owner & President of the #1 ranked Business Brokerage, Business sales and M&A firm in Texas. Scot has been named Named Deal Maker of the Year by Dallas Business Journal.
He is committed to a “different” type of business brokerage firm, one that is NOT about a sales pitch but, rather, results! In short, a business brokerage firm that is committed to performance-based compensation. Scot believes in these principles as well as a candid honesty with clients. His candid style often takes buyers and sellers by surprise, but is often what assures successful connections between the two.
Feel free to reach out!