There are many important aspects of a successful business transition. One of those is how to finance it. As a seller, the last thing you may be thinking about is the need for financing; however, without a good financing option, your buyer may not be able to complete their end of the deal.
Financing for the purchase of a profitable business may seem simple, but there can be a lot of complexities involved, even for an experienced business borrower. These include whether the sale is of the business assets or the stock, what type of assets are being purchased (equipment, inventory, real estate), whether the buyer is going to retain the key leaders of the business and so on. Often, the financing of a business purchase involves using multiple financing products.
The standard loan product for financing a business acquisition is a term loan that is structured so that the acquisition costs can be paid in full as quickly as the business cash flow will reasonably allow. A good banking partner won’t stretch the business cash flow so thin that it harms the business. Still, it should be structured so that the buyer isn’t still repaying acquisition costs long after the purchase.
Repayment terms on business acquisition loans typically range from three to seven years, but they can be longer, depending on the circumstances. The proper term will be determined by how much cash is left after all other business expenses have been paid. Most banks will require this amount to be not less than 1.2 times the amount of the loan payments.
BLUE SKY FINANCING
One of the biggest challenges in financing a business purchase is the equity piece. A motivated seller will likely want to earn a nice profit
from the transaction; therefore, the asking price is often some number greater than the value of the business assets. This is commonly referred to as Blue Sky or Goodwill, and it represents the future profit potential of the business. The hard part in financing Blue Sky is that it doesn’t exist at the time of the sale. Whereas a piece of equipment or a building acquired in a business purchase has a defined market value that is predictable going forward, the Blue Sky piece is uncertain. Lenders can often mitigate some of the Blue Sky financing risk through a guaranty from the U.S. Small Business Administration. Another tool would be requiring the buyer to pledge other assets outside of the business to collateralize the loan.
A buyer should be prepared to contribute a minimum of 20 percent cash toward the purchase price. That percentage can be higher based on the type of business. In addition, most lenders will require a buyer to have excess cash available to cover the working capital of the company, though this can also be accomplished with a line of credit loan that is separate from the term loan.
SELLER CARRYBACK NOTE
A lot of business purchases also include what’s known as a seller carryback note. In this scenario, the seller agrees not to take the entire purchase price at closing but rather leave some of it in the form of a loan to the buyer that is repaid over time.
A good banker will sit down with you to determine which financing tools make the most sense for your deal. The sooner that conversation takes place in the process, the better.