How to Finance the Purchase of a Business
When a business owner sits down to discuss the sale of his business with a potential buyer, he should keep in mind the various financial formulas that could eventually be applied to the operation. A financial expert would say that closing some deals requires “getting creative.”
Since the ideal situation of payment by "a single check" does not always materialize in all business purchase-sale transactions, we will analyze here some alternate cases.
Bank financing
The Great Recession that began in 2007 and began to subside in 2011 left a clear lesson for North American businessmen in relation to the use of bank credit. There were many stories of bankruptcies and even suicides generated by this fateful period of our contemporary economic history.
The mistrust of the business community, together with the government's restrictions on the financial activity of the banks, substantially reduced the dynamics of indebtedness that existed before the recession. Banking today feels comfortable only when it finances companies that have ample asset collateral, solid cash flow, good profit margins, and owners willing to provide personal guarantees.
However, although the traditional banking formulas have taken a backseat in business preferences, the programs of the Small Business Administration (SBA)) continue to drive innumerable small and medium-sized business projects. Thus, under the program known as “7(a)”, loans granted by banks with SBA guarantees can reach up to $5 million without an established minimum.
The SBA guarantees a maximum of 85 percent of loans up to $150.000 and 75 percent of loans over $150.000. It will not guarantee more than $3.75 million.
For loans of $150.000 to $700.000, the rate is 3 percent. For loans of $700,000 or more, it is 3,5 percent. For loans over $1 million, there is an additional 0,25% fee.
Interest rates are negotiated between the applicant and the lender, but cannot exceed SBA maximums. Payments are made monthly and include a combination of principal and interest, just like a traditional loan. (www.sba.gov)
Seller Financing
Given the restrictions of the bank, the seller's credit appears as an excellent alternative to bring the sale of a business to a successful conclusion. Thus, the buyer pays an initial fee between 20% and 50% of the amount and signs a promissory note for the difference in the purchase price.
The promissory note must stipulate the guarantees granted by the buyer and set the payment conditions. In operations of small and medium-sized companies, the term can range between 2 and 5 years and the interest rate between 5% and 10% per year.
There are several benefits that arise for the Seller and the buyer in these transactions. The most notorious are the following:
- The period for closing the operation is shortened because the bank evaluation process is eliminated.
- It is possible to replace an eventual negotiated reduction of the sale price by the granting of terms to pay.
- The seller spreads the benefit of the sale between several tax periods.
- The seller obtains better interests on the balance than those paid by the bank.
- The buyer can access the operation with fewer resources.
- The buyer's qualification is made by the seller and not by the bank.
- Payments for points, origination, appraisals, credit reports, title insurance and other fees charged by conventional lenders are not contemplated.
Seller financing is usually secured by the assets of the business or by stock if it is a corporation. When seller-owned assets are encumbered, a UCC-1 financing statement (Uniform Commercial Code-1) must be filled out to publicly attest that the seller has a claim against the buyer (www.floridaucc.com).
Conclusions
Among the available options on How to Finance the Purchase of a Business It is important to estimate “a priori”, in detail, the capital requirements and take into account that each new business has a break-even point that must be reached in a timely manner. The glorious moment in which the income exceeds the expenses will depend on the correct planning of the future that the buyer has estimated.
Then the creativity of the buyer will be the fundamental element for his business success. Here what Peter Drucker once said is applied to the letter: "The best structure will not guarantee results or performance, but the wrong structure is a guarantee of failure."
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Author: Alfredo Gonzalez I www.negociosenflorida.com