If you buy a business with seller financing the person whose business you're getting agrees to accept a promissory note for part of the payment.
While most people in the business for sale market know about this, they may not understand the importance or the method of structuring the purchase agreement so that it supports the objective of the seller-financing plan.
Three common examples of what the buyer should request when negotiating for seller financing are:
1. Seller in "standby" position: If the buyer plans to get a loan from a financial institution for some of the cash that will be needed to buy or to operate the business, the seller financing language in the sales agreement should state that the seller agrees to allow another lender or lenders to be in first position among creditors. The seller, in standby position, may be able to take over some of the assets of the business to recover any loss if the buyer defaults on either loan. But that's only after the institutional lender - such as a bank or financing company - has seized the assets necessary to be reimbursed for its loss. When negotiating the transaction, the buyer needs to get seller's agreement to take a "standby" position behind creditors furnishing cash for the purchase.
2. Seller financing with earn out provision: More and more business sales contracts include an earn out agreement as a way for the buyer and seller to achieve a transaction even if they disagree about what price is to be paid. Buyers encounter situations in which the seller sees the business improving and considers its value to be what it "will be" worth in the near future, while the buyer thinks the correct price to pay is the value of the business at the present time. The solution to this problem can be an earn-out agreement. It will allow for the price to be adjusted over the months or a few years following close of escrow, in step with improvement of the business. That improvement usually is based on some mutually-agreeable measurement such as gross sales or owner's earnings before deductions for interest and taxes paid and allowances for depreciation and amortization. Most often, any changes in price following close of escrow, are reflected in changes in the amount of the promissory note held by the seller. In other words, if the value of the business increases, the buyer's payments to the seller will go up by a prescribed amount. In this kind of transaction, the buyer should make certain that the earn-out description in the sales agreement, and any formulae to be used, are clearly explained in writing and acceptable by both parties.
3. Balloon payment to seller anticipated with buyer's plan to refinance original purchase loan or loans in months or a short period of years following close of escrow: Refinancing can be accomplished once a buyer has gained experience and can demonstrate a solid track record of running the business successfully. In some cases, the promise of a balloon payment to be made to seller is a workable compromise between a seller who wants an all cash deal and a buyer who wants traditional seller financing. Terms of the balloon payment should be clearly stated. Payment may, for example, be contingent on the buyer being able to obtain additional funds to pay off a purchase loan from a financial institution and/or provide the seller with the balloon payment. In some cases the refinancing will enable the buyer to retire a "bridge" loan taken as a temporary measure for the cash required to help fund the purchase or provide for operating capital needs.
Seller financing can take many forms as it is used for part of a buyer's business purchase financing strategy. Buyers are cautioned to plan ahead for the various situations with clear and detailed description of the seller financing agreement in the sales contract, so that it corresponds with the overall financing plan.
About The Author: For over 25 years Peter Siegel has provided niche business purchase financial advisory and loan/financing placement services with SBA Loans, Non-SBA Financing, Retirement Plan Conversions (without Taxes & Penalties), Private Investors, Hard Money, etc. Financing amounts available: $10K to $5M. Call me today direct to get professionally pre-qualified or get financing to buy a business: 866-270-6278 (if you get voicemail - leave a detailed message and I will phone you back promptly!)
Categories: BizBen Blog Contributor, Business Purchase Financing, Buying A Business, Deal And Escrow Issues, How To Buy A Business, How To Sell A Business, Selling A Business, Small Business Financing
|Helpful Resources To Assist In Selling And Buying California Businesses|
|Janet Carrera - Escrow & Bulk Sale Services - SF Bay Area
Redwood Escrow Services, Inc. is a full service, licensed independent escrow company. We are EAFC Fidelity bonded, fully insured & licensed with the Department of Corporations. Committed to offering our clients the most comprehensive variety of escrow services available. Phone Janet at 510-247-0741.
|Helen Yoo: Escrow & Bulk Sale Services - Southern California
New Century Escrow, Inc. is a fully licensed & bonded independent escrow company. Over 20 years combined experience in handling bulk escrow transactions. Multi-lingual staff that speaks your language, including Korean, Chinese, Vietnamese. Call Helen Yoo direct at 626-890-1151.
|Ranvir S. Sandhu, Esq. - Legal Services For Buyers And Sellers
I've worked at top Bay Area law firms and have extensive experience with business entity formation, mergers, dissolutions, conversions, employment matters, including experience in reviewing and negotiating transactional documents such as leases and purchase agreements.
|Elizabeth McGovern: Escrow Services - SF Bay Area
McGovern Escrow Services, Inc., is a leading independent escrow company. We are a trusted partner with our clients, assisting them through the tangled bulk sale & liquor license transfer process. We provide attentive, quality & innovative customer service. Phone Elizabeth McGovern at 415-735-3645.
|Mark Chatow, Esq.: Legal Services For Buying, Selling Businesses
Mark has a broad range of small business purchase & sale experience from analyzing potential acquisition targets to successfully guiding buyers and sellers through the purchase & sale of small businesses. Mark can assist with contracts, negotiations, legal matters, etc. Reach Mark at 949-478-8393.
|Joe Sandbank, Esq. - Legal Services
I have provided legal counsel to business buyers, sellers and brokers for over 17 years. With prior experience as a business broker and SBA loan officer, Joe brings both a practical and legal approach to all aspects of the business acquisition process.
|Willard Michlin, CPA, Certified Fraud Examiner, Due Diligence Services
Willard Michlin, CPA #106752, offers buyers step by step training & assistance in doing Due Diligence Services when they are thinking of making an offer, or are in process of investigating a business purchase. He helps to determine the actual net profit even when there is cash. Call 805-428-2063.
|Diane Boudreau-Tschetter: Escrow And Bulk Sale Services
California Business Escrow, Inc. is a full service independent escrow company serving all of California and has expertise in a wide range of escrows. Our team prides itself on providing an exceptional escrow experience. For more info phone Diane Boudreau-Tschetter at 888-383-3331 or 209-838-1100.
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