How Deal Terms Impact the Sale of Your Business

Terms of the Deal

When it comes time to sell their business, most business owners would love to receive a big check at the closing table for the full amount of their asking price. In the case of most business deals – especially for larger businesses worth over $1M – this seldom happens. In order to generate a higher rate of return on their invested capital, buyers generally seek deal terms with partial seller-financing or external financing. Compared to an all-cash deal, a partially seller-financed deal generally results in a higher overall purchase price in order to compensate the seller for incurring risk of the buyer defaulting. The purchase price of an externally financed deal – assuming the business is financeable – must stay within its appraised value as determined by the lender. The payment structure of a deal (cash v seller-financed) along with escrow amounts, non-compete and indemnification clauses, and tax implications often outweigh the importance of the headline purchase price.

Consider Deal Terms When Setting Asking Price

A common mistake made by many business owners is not factoring in the type of deal terms they are willing or able to accept when determining their asking price. A business priced at $1M where the seller will only take all cash up front at closing differs dramatically from a business priced at $1M where the seller is open to seller-financing or external financing. For psychological reasons alone, many buyers simply refuse to deal with a seller who requires all cash up front. Rather, they expect the seller to stand behind the value of their business by accepting some seller-financing. For externally financed deals including those backed by the Small Business Administration (SBA), lenders invariably require the seller to accept some seller-financing as a part of the deal structure. The asking price for businesses which qualify for external financing and where the seller is open to seller-financing will enjoy a premium compared to businesses that are only available for all-cash up front buyers.

Externally Financed Business Deals

  • The SBA funds business deals via 7(a) loans where the SBA acts as the guarantor of the loan used by the buyer to purchase a qualifying business.
  • Third party financial institutions such as banks deal directly with the buyer as the facilitator of the loan.
  • Buyers may get pre-qualified to purchase a generic business for a maximum amount by their bank, but the SBA often requires buyers to have the necessary background, skills, and licenses needed to operate a given business prior to approving a loan.
  • A buyer will also need to pledge a necessary amount of collateral to secure their loan, incur all appraisal fees, and pay at least 10% of the purchase price in cash at closing.
  • The business itself must also qualify for the loan by having a transparent set of financials and business records that substantiates the sales, profits, and overall value of the business during the appraisal process.
  • Without an accurate set of historical financials going back three years, it is very difficult for businesses to qualify for external financing.
  • In this case, business owners may consider offering some seller-financing as a deal term.
  • Importantly, business owners should be aware that externally financed business deals also require some seller-financing.
  • The SBA very often requires (especially with service-related businesses lacking tangible assets) the seller to hold back about 10% of the purchase price.
  • This is a means to assure the SBA that the seller will assist with the buyer in the long term after the closing.
  • A seller’s note within the context of an SBA-financed deal is often subject to a standby provision where the seller’s note does not begin to be paid for two years or more.
  • Moreover, this type of seller’s note is subordinate to the note held by the SBA itself.

Seller-Financed Deal Terms

Traditional seller-financing involves the seller holding 50% or less of the purchase price in the form of a seller’s note. The seller’s note is paid by the buyer over a set period of time (ranging from 2-5 years) and is secured by a Uniform Commercial Code (UCC) Lien placed by the seller against the assets of the business. Minimizing the risk of seller-financing is a major concern for many business owners and may be alleviated by increasing the required amount down, evaluating the buyer’s qualifications to run the business successfully, and properly securing the note against other potential lien-holders. When offering seller-financing – especially when external financing is unavailable – business owners greatly increase the pool of potential buyers that can afford to purchase their business or will consider purchasing their business. This creates a liquid market where a sufficient number of buyers may bid against one another, thus elevating the ultimate purchase price.

Non-Traditional Deal Terms

Business owners should generally be wary of non-traditional deal terms such as an earn out, paying the seller as a salaried employee after the closing in lieu of the purchase price, or a seller’s note that is not accompanied by at least 50% of the purchase price down at closing. An earn out is where part or all of the purchase price is only paid to the seller after the closing if future financial targets of the company are achieved (often years after the closing). Unless considered as a bonus to the actual purchase price, an earn out should be viewed with extreme caution by business owners. Likewise, compensation for the seller after the sale as a salaried employee or consultant is also not guaranteed and should not be viewed as a substitute for the purchase price of the business. A non-traditional Seller’s Note that does not include at least 50% of the purchase price down at closing is very rare and generally only occurs when the business owner has an unusual reason to sell quickly.

The terms of a business deal greatly affect its overall purchase price, the types of buyers that are eligible to purchase a business, and the length of time it takes to attract the right buyer. By consulting with a professional business broker, business owners should understand whether their business is a good candidate for SBA-backed external financing or whether they should consider offering some seller-financing in order to attract more buyers. Non-traditional deal terms should generally be avoided as they are not guaranteed and tend to impose undue risk on the seller.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.