For business owners who WANT to sell now or NEED to sell their business now, there are some realities that they should consider at the moment. Businesses are still selling and deals are still being done, but creative financing will be the name of the game moving forward, for at least the next several months as our economy begins its incline back up towards recovery.
In a healthy market, we estimate that about half of the business closings we assist with are funded using SBA guaranteed bank loans, around one quarter are done using seller financing/owner carry, and about one quarter are all-cash buyers. Acquisition loans backed by the SBA have understandably become scarce and are more difficult to secure at the moment. Banks are only lending on businesses that are open and financially healthy, if they have the funds to do so. The SBA 7a loan program is in the same bucket of money as the PPP loans provided by the CARES Act. So, once that second wave of funding is depleted, we are told that funds for SBA 7a loans will be temporarily unavailable too. Experts estimate that it could be months before that fund is replenished. Of course, the only thing we can count on at the moment is change, so we are keeping our eyes and ears open every day for new announcements from the SBA and from our lender contacts.
There are still cash buyers out there, but buyers are being more cautious than ever with the cash that they have at their disposal. So, naturally, they are looking to mitigate their risk of buying a business during this time by utilizing seller finance, or in some cases (where it makes sense) an earn-out. We are going to take a look at these two options here, so that business sellers can be as informed as possible when it comes to the kind of financing that buyers might be requesting of them at this time.
Offering owner carry or seller finance will make the business much more likely to sell, even more so during today’s economic circumstances. In a normal market, it is estimated that businesses who offer seller financing are 4 times as likely to sell, compared with similar listings that don’t advertise seller financing; therefore, one can infer that offering seller financing is practically essential if the seller wants or needs to sell now. In addition to selling faster, sellers earn interest over a certain period of time, and it can provide significant proceeds to the seller. Also, receiving installment payments may provide significant tax advantages for the seller. Sellers will of course need to check with their CPA for financial advice on tax matters.
50% down is the most common buyer down payment, but it is completely up to the seller as to what they would accept, and we see 20-30% down payments happen frequently. The term length of the loan is usually very short. 2-5 years is what we see most commonly. Normally there is a balloon payment at the end of this short term if monthly payments are amortized over a longer period of time, to decrease the monthly payment amount. Otherwise, all payments are spread equally over the term length. There are no large closing costs involved or bank fees, and we typically see 7-9% interest these days. The tangible assets are used as the security for the loan. If the buyer defaults, then the seller keeps the buyer’s down payment, in addition to receiving the business and its assets back. Typically, the closing attorney will be able to draw up the promissory note for the parties to sign at closing, which normally the buyer pays for, since they are the borrower.
An earn-out is a contingent payout, which essentially involves shifting some of the purchase price to be paid in the future on the realization of future earnings or some other benchmark of success that the parties agree to. So, in this case, the business owner needs to be willing to delay some of the agreed purchase price and be aware they might never see it if the business performs poorly in the future. This is obviously a less favorable option than offering seller finance for the business, as the seller isn’t earning any interest on the part of the purchase price that has been “delayed.” Furthermore, the earn-out is all based on the performance of the business, which after the sale, the seller won’t have full control over any longer. It mitigates risk for the buyer, and depending on the current performance of the business, it might be the only way to get a buyer to agree to taking the plunge.
Earn-outs are much more widely used in the M&A (Mergers & Acquisitions) arena, when multimillion-dollar companies are being bought and sold. We typically don’t see earn-outs very often in our world of small to mid-size business sales, mostly because they can be a complicated beast, and require the earn-out to be highly thought out, with each detail accounted for. Additionally, these agreements can get quite expensive for attorneys to draft. Of course, a buyer and seller of a small business can negotiate and agree on the earn-out between them without professional aid, but we would always advise both parties to seek legal assistance with this.
Just like with seller financing, the cash down payment from the buyer is normally significant. Typically, it will be 30%-50% of the purchase price, but is always up for negotiation.
Want To Find Out More About Selling?
Every business owner’s situation is unique, and if you are interested in talking to us about your options for selling your business, we are happy to have a chat with you to see how we might be able to help. As always, conversations with us are completely confidential, and there will be absolutely no pressure from us to list your business now. We only want to work with business owners who want to work with us and who are ready to sell their business. Furthermore, if we don’t think it’s the right time for you to list your business, we will give you our honest opinion. It is our number one objective to always do what is in the best interest of our customers, so rest assured that your goals are our goals too.