Buyers have some options for Business Acquisition Funding
You have finally decided that it’s time to sell your business. You want to spend more time with the family, travel a little, and pursue all of your other interests.
We’ve already explored ways to work with your business broker to protect confidentiality, maximize business value while minimizing the bite of the tax man, and the importance of running your business as if a buyer is going to approach you tomorrow.
One area that may cause you concern, however, is the lack of availability of credit or business acquisition funding for potential buyers.
Let’s face it:
Credit markets have changed. The days when lenders were willing to risk financing a business acquisition with little investment (skin) on the buyer’s part are gone. In today’s world (and the foreseeable future), business acquisition funding will take more creative approaches.
Normally, there are three components that determine the final sales price when selling a business:
- the market value of Furniture, Fixtures, and Equipment necessary to the operation of the business;
- the value of existing Inventory; and
- the difference between the Market Value (selling price) of the business as a going concern and the total of Furniture, Fixtures & Equipment, and Inventory. This difference is called Goodwill.
Goodwill is the additional amount, over and above the value of hard assets, which a buyer is willing to pay for the business.
This excess value includes the earnings of the business, cash flow, market standing, proprietary products, secret recipes, reputation, name recognition – all intangible elements that add to the value of the business.
Goodwill is a component that lenders and investors use to evaluate the “risk” involved in the deal. In the case of a default, they may not be able to recoup the money they loaned against Goodwill.
This is where a buyer can run into trouble with financing, especially when buying a mature business.
Generally mature businesses are just that – mature. They have been around a while. They have experienced success and used the fruits of that success to pay off debts (loans), making the business even more successful. They have established a reputation in the market and may have proprietary products.
As the business has grown over the years, the amount of Goodwill has grown as well. Add to that the fact that the Furniture, Fixtures and Equipment purchased through the years have been depreciated. They are now less valuable on paper, even though they are extremely valuable to the business in producing cash flow. All this is involved in computing the value of Goodwill, and again, this is where lenders define their risk.
Long story made short: you want to sell your business and a buyer wants to purchase it. The value of the hard assets alone isn’t equal to the market value of your business and therefore the lender is hesitant to lend against the difference (the Goodwill).
What are the Buyer’s options for business acquisition funding?
- Pay the entire business purchase price out of pocket.
- Pledge personal cash and/or equivalents of real estate or other investments to guarantee the debt.
- Secure lender financing, a much more difficult option in the current economic climate than in the past. Lenders in the current and foreseeable future will be very conservative in assessing “risk.” They are lending less against depreciated Furniture, Fixtures & Equipment, as well as against Inventory. Moreover, they are more risk-averse in lending against cash flow and Goodwill.
- Seller financing
- Or a mix of all the above.
The reality is that very few potential business buyers have the cash for the first option. Each of the other three options comes with its own limitations. This is when the seller often makes the transaction happen by offering seller financing…it can mean the difference between closing the deal or missing a great opportunity.