It is important that a seller should NOT ask for all cash. These are a few of the reasons:
1. It drastically reduces the number of prospective buyers in the marketplace and will therefore extend the time it will take to sell the business.
2. It gives the buyer the impression that the seller must not confident in the business.
3. It there a lending institution (SBA or other Bank) also providing funds to the buyer, they will not finance goodwill, therefore, if goodwill does exist in your business (and it almost always does), you and/or the buyer will have to finance the goodwill portion of the purchase price.
4. In almost each and every business sale, a higher price can be obtained if terms are offered to the buyer. A buyer will want to discount the ultimate negotiated selling price for a cash sale. Since most small business sales don’t include the seller’s bank accounts or its accounts receivable, a buyer will want to preserve its down payment since additional cash will be needed as working capital to operate the business.
5. The seller’s tax liability on the sale can be deferred if terms are given to the buyer. Basically, the seller will pay its share of the tax liability as the installment sale payments are received from the buyer. If an all cash deal were negotiated, the tax would have to be paid on the entire gain in the year of sale and, as a result, only the net after tax proceeds would be available for the seller to invest.
6. The seller will usually receive more for the business as a result of the interest paid to it over the life of the loan. If a seller is taking back financing, a larger interest rate can be negotiated from the buyer that would otherwise be charged from traditional lending institutions (perhaps 2% or 3% over the prime rate). This final buyer interest rate is almost always greater than the interest rate the seller would receive if he invested the net business proceeds into traditional type investments.
IF A SELLER DOES TAKE BACK FINANCING, THEY SHOULD:
- Determine the creditworthiness of the buyer (a Financial Statement is a must, even a credit report)
- Determine if the buyer is qualified to manage the business
- Require the buyer to put down a sizeable down payment (at least 30%). With this percentage of down payment, the buyer will now have a substantial vested interest in managing the company and effectively protect his or her investment.
- Require the buyer to repay the balance over a period of up to five years, but no more than 7 years. If real estate is involved, a longer payback period may be warranted. A balloon payment provision should also be considered to shorten the final payback period to the seller.
- Require the buyer to personally sign a promissory judgment note for the balance owed (a spouses signature would be preferred and would further protect the seller but this is not always easily accomplished.)
- File UCC Security Agreements to protect the seller’s interest in the business and assets sold to the buyer.
- Require the buyer to provide the seller with monthly or quarterly financial statements and annual tax returns of the business. This will permit the seller to regularly monitor the financial health of the business and spot any potential problems before they occur.
- Make sure the buyer’s promissory judgment note contains a confession of judgment clause along with a hefty default penalty provision and the inclusion of attorney’s collection fees in the event of default.
Read our special reports concerning selling a business. The next step is to call us at 610-353-8244 or fill out our simple information request form, and a Business Exchange Network professional will contact you immediately.