Seller financing a key to attracting more buyers, maximizing your sale price

In many business sales, the seller’s excitement at receiving a letter of intent from a prospective buyer can give way to disappointment, when they see that the proposed terms of the deal require the seller to finance a substantial portion of the purchase price.

Clinging to their expectation for a clean break with no post-closing entanglements, more than one seller has been tempted to reject such an offer and wait for a “stronger” buyer who will pay top dollar in cash.

However, as most M&A brokers and experienced sellers know, the great majority of business sales involve some form of seller financing, with the higher the selling price the greater the likelihood of a seller carryback.

The seller might be the only lender in the deal, receiving a down payment (typically 30% to 90% of the purchase price) and carrying back the unpaid balance for five to seven years. Or, less appealing, the seller might be asked to subordinate their carryback to the buyer’s bank loan or other form of leveraging.

Part of the M&A professional’s role from the outset and throughout the sale process is to:

• manage the seller’s expectations so that they are not surprised when an offer calls for a carryback;

• help the seller understand why a good buyer – even a presumably cash-rich multi-national corporation – would require seller financing;

• help the seller appreciate the real benefits (and risks) that stem from their willingness to finance a deal; and

• guide the seller through the heightened importance of the due diligence phase, to ensure the buyer’s creditworthiness and business acumen.

WHY A BUYER MAY REQUIRE SELLER FINANCING

A buyer that can’t or won’t pay cash for your business is not necessarily a weak buyer – far from it. You should expect that prospects from anywhere on the desirability and profile spectrum – individual buyers, strategic buyers, and financial buyers – are likely to call for a seller carryback.

Here are some very legitimate reasons:

• They want to buy your company for $X million but don’t have that kind of cash sitting around.

• They do have access to that much cash, but if they give it all to you, that would prevent them from putting that money to work elsewhere or buying other businesses.

• They want to invest some of their liquidity into expanding and improving the business that you are selling to them.

• Their purchase of your business involves you making certain warranties and representations or carrying through on one or more post-closing commitments, and the promissory note for the unpaid purchase price gives them a source of offset in case you don’t deliver.

SELLER FINANCING PROS AND CONS

Consider the “Cons.” You probably have already started a mental list of reasons not to carryback part of the sale price, most of which start with “risk of”:

• Risk of Default on Your Loan. If the buyer defaults on their payments, you face taking back the company and enduring the associated legal hassles and costs. Then you have to find a new buyer for a business that probably isn’t worth as much as the one you sold. (That is why you should negotiate a relatively high down payment – e.g., 30% to 40%.)

• Risk of Default on the Loan that’s Ahead of Yours. If the buyer defaults on the acquisition loan, the proceeds of which made up all or part of your down payment, you have to cure that default before you can get back your former company. If you don’t, the primary lender will flip the business or liquidate the collateral, leaving you with little left to recover.

• Risk of Waiting to Get Paid. If there is a lender ahead of you, they may require you to go on “standby,” delaying receiving the payments on your note (two years is common) until the buyer has established a reliable loan payment record with the primary lender.

• Risk of Lower Rate of Return. Interest rates on seller carrybacks are usually below market, meaning that your rate of return might be less than if you had sold your business for cash and put the money to better use.

• No Clean Break. Your vision of simply walking away from your company on closing day with a big bank deposit is a mirage.

Those are legitimate concerns, and carrying back a portion of the sale price might not suit you or your situation.

The “Pros” Are Huge. But before you conclude that seller financing isn’t for you, consider the potential enormity of the benefits:

• More Prospective Buyers. By keeping an open mind on seller financing, you expand the pool of potential buyers – including buyers at the upper echelons of the market – by a factor of three or more. Demand cash only, and you eliminate 60 to 80 percent of your potential buyers.

• Higher Selling Price, Part 1. Expanding your buyer pool increases your prospects for creating a competitive bidding situation. The resulting “auction environment” helps drive up the demand and price for your business.

• Higher Selling Price, Part 2. Just as a cash buyer (of nearly anything) expects to pay less, a realistic “credit” buyer should expect to pay more. By offering seller financing, you elevate the price ceiling on your company, and the higher selling price helps you make up for losses of liquidity or rate of return that can accompany deferred payments. At the very least, even in a cash deal, your expressed willingness to carry back part of the sale price gives you a negotiating tool.

• Higher Selling Price, Part 3. By deferring some of the purchase price, a buyer can afford to pay more for the business.

• Higher Selling Price, Part 4. A seller who is willing to invest and assume risks in the sale of their business is sending a strong message to potential buyers: I believe in my company, and I am confident you will have success in owning it. That in turn gives buyers and their lenders confidence that their purchase (remember, it’s a risk for them, too) will pay off.

• Higher Selling Price, Part 5. By our rule of thumb, the seller in an IBG deal can expect the aggregate benefits of parts 1 through 4 to yield a selling price 15 to 30 percent higher than in a cash-only sale of the same business. Consider the possibility that, by demanding cash, you may lose the opportunity to receive just as much cash at closing from a better buyer plus the value of the note you carry.

• Less Complexity, Part 1. Financing the sale of your company spares the buyer from jumping through the multitude of hoops and costs that are inherent in getting a bank loan (SBA guaranteed or not) and that can delay or threaten your deal.

• Less Complexity, Part 2. Keeping the terms of the sale between you and the buyer eliminates the meddling of third-party lenders and allows the parties to retain more control over the deal.

• Leverage in Due Diligence. Seller financing can help level the playing field during the due-diligence phase, where in many cases the buyer is calling the shots. That is somewhat less true if the buyer knows that, while you are trying to satisfy their requests for information, they also have to demonstrate their creditworthiness, financial strength, industry knowledge, business track record, and business growth planning skills to you, their new “banker.”

• A Good Investment. While you might fear that tying up part of your sale price will hurt your investment yield (see “cons” above), that fear might be unfounded. The promissory note you take from your buyer constitutes an investment in its own right – one that, favorably structured, might provide a return equivalent to the stock market or other investment options.

• Tax Benefits. Spreading out your sale price and capital gains in an installment sale should allow you to defer your tax liability and manage it to your advantage.

THE BIG PICTURE

There’s no question that negotiating the terms of the promissory note, filing UCC-1s, negotiating the tax treatment of the deal, etc., are inconveniences that add a layer of nuisance that doesn’t generally apply to a cash deal.

And, yes, things can go wrong. But you have been staring risk in the eye – and prevailing – for as long as you have owned a business, and now is not the time to become unduly cautious.

In the end, your willingness to finance the sale of your business will attract more buyers, drive up your ultimate selling price, and maximize the benefits of what is likely the most important business transaction that you will ever encounter.

The M&A professionals at IBG Fox & Fin and our nationwide IBG Business partner firms can help you do it right. You can take comfort and confidence in our decades of business transaction experience, more than 1,100 successful closings, and our nearly 90% deal closing rate – three times the industry average – involving private mid-market companies of all sizes and complexities.