Generally speaking, there is an overriding negative connotation amongst business owners when it comes to the subject of carrying a note as part of a business sale. While many of the seller financing horror stories floating around the golf course and dinner party are true, when seller notes are structured properly with equitable terms, they can be invaluable tools to closing a successful transactions.
In this article, we’ll explore some of the most common objections to seller financing and then provide some counterpoints to those objections to give you something to consider and maybe a new perspective.
OBJECTION: I'll get less cash at closing
Correct. That’s a fact. So what could possibly counter that point?
How about if I told you that yes, you’ll get less cash at closing, but in exchange you’ll actually be getting a higher sale price for your business?
The fact is, that result is overwhelmingly common. Surely you’ve heard of the old “cash discount” in some form or fashion – the same principle actually holds true when it comes to business acquisitions also. This is the case for two main reasons.
First, if a buyer is willing to pay cash for a business, he or she is undoubtedly going to assume the seller’s desire for a larger amount of cash at closing will outweigh the seller’s desire to get his or her asking price. So the buyer offers a lower cash price. But if you’re willing to carry a note, the buyer loses some of his or her negotiating leverage. Sure, you get less cash at closing, but you’ll end up with a higher sale price overall.
Second, if a seller is unwilling to carry a note, this negatively impact the buyer’s confidence in the business and the sale price, so the buyer ends up offering a lower price to account for that perception of increased risk. But if you are willing to finance a portion of the sale, it actually increases the buyer’s confidence in your business and its value, and he or she is more likely to agree to a higher price.
OBJECTION: It will take longer to get my money
Again, correct. No argument here. If you choose to carry a note as part of your business sale it takes longer to get paid.
With that said, think about what seller financing really is – it’s just an investment in your business. If I were to ask 1,000 business owners to rank what they felt the most confidence in between the the stock market, the real estate market, the energy market, the bond market – any market out there – or their businesses, I’d bet a dollar that the vast majority of them would have their businesses at or near the top of that list.
Most likely you are going to invest a portion of the proceeds from the sale of your business, so why not invest in something you truly understand better than anything – your business? Also, typical seller financing is going to range from 24 to 60 months and 5% to 8%. Where else are you going to be able to invest in something you have intimate knowledge of, and at the same time get a guaranteed return like that?
Another benefit to the delayed receipt of your seller-financed portion is from a tax perspective. If you sell your business for $1 million cash, you pay taxes on that $1 million that year. However, if you sell your business for $1 million with a five-year $250,000 seller note, you’ll only pay taxes on $750,000 this year, then on $50,000 per year for the next five years. Depending on your tax bracket, this could prove to offer considerable tax savings.
Yes, seller financing means it takes longer to get your money, but you’ll net out much better in the end when you consider the proceeds from interest and the deferred taxes on your note.
OBJECTION: The buyer might not pay me
Correct. Just like when a bank lends money to you for the purchase of a car or a house – there’s no guarantee you will ever pay them. But what does a bank do to counter that risk? It has security interest(s) as collateral.
The same principle applies for seller notes on business acquisitions. This is where an experienced broker can really add value to your transaction – making sure you are properly protected if you choose to carry paper.
If drafted properly, a seller note should include a security agreement that collateralizes the assets of your business that are being conveyed to the buyer. It should also include a personal guaranty from the buyer for the amount of the sale price in excess of the asset value. If losing the assets o the business they just bought isn't incentive enough to pay you, then risking their personal assets can be.
Additionally, the seller note should have a clear definition of what constitutes buyer default. In the unlikely event a buyer does stop paying on the note, you need to be able to act swiftly and decisively to foreclose and reposes the assets and the business. Then you can straighten things out and sell it again if you wish!
OBJECTION: The buyer could run the business into the ground
This is another correct statement. Whoever buys your business could fail miserably, causing the business to close down and leaving you with very little value to take back.
While this scenario is more unlikely than anything we’ve discussed in this article so far, there are still some safeguards you can use as protection from something like this.
The most obvious and most important is simply to evaluate your buyers. No one knows better what it takes to successfully run your business than you do. So make sure that you feel confident in the person or people buying it.
If you’re going to carry a note for someone and expect to get paid back, he or she needs to have the skills to operate your business. That doesn’t mean you need to think they’ll be more successful than you, and it doesn’t necessarily mean they have to have direct industry experience – it just means you need to feel good about their abilities.
Another thing you should require that will help you avoid a situation like this is for the buyer to provide you periodic financial statements on the business so you can monitor how they are doing. Typically these are done quarterly. So if you start seeing a disturbing trend or noticing the buyers are struggling, you can offer your assistance to help straighten things out. What better way to protect your investment than to be able to be hands-on if needed?
OBJECTION: The buyer can just get a bank loan
In some cases, bank loans are simply not available. This has more to do with the quality of your business and the accuracy of your financials. But let’s assume your business and your buyer do qualify for bank financing – that doesn’t mean seller financing is off the table.
In fact, more times than not there will still be a seller note in your deal even if the buyer gets bank financing. This is the case for two main reasons.
First, it gets back to confidence. Not only might the buyer feel better about acquiring your business if you are willing to carry a note, but the bank often has the same opinion. Everything about the deal feels stronger from that side of the table when the seller has some skin in the game.
Second, many transactions “need” seller financing to make the numbers work. It might be because your business has a lot of goodwill and not a high tangible asset value, or it might be because there is a risk the bank sees in your business that it wants to mitigate by making you have an interest in the future success, or it even might be because the buyer is a little short on the down payment and the bank needs your note to bridge that gap.
The good news in these types of situations is that your note is going to almost always be much smaller than it would have been if there was no bank involved. Generally speaking, a seller note on a bank deal will be about 5% to 10% of the sale price, while a deal with no bank involved could be as high as 50%.
Seller financing is definitely one of the biggest lighting rods when it comes to selling your business. While there are some fundamentally factual objections against carrying a note, there are also just as many logical and proven solutions to counter those objections making seller financing a tremendous tool to have t your disposal. Whether you’re considering selling your business this year or in 10 years, it would be prudent to contact a reputable business broker, like Sigma Mergers & Acquisitions, today for a no cost, no obligation business valuation. This is not only a great way to examine your business’ value, but also a way to see what type of seller financing options make sense for your business to maximize its overall value.