HOUSTON BUSINESS REVIEW

TUTORIAL ON SELLING YOUR BUSINESS: “Other Factors to Consider When Selling” – Part II
By Ralph Fain

Ralph Fain is a principal in the R/ Fain Group, a professional business brokerage firm which confidentially represents the interests of sellers/ buyers of “Mainstreet to Mid Market” companies (revenues from $1MM to $25MM). Mr. Fain has over 20 years of broad business experience with Fortune 500 companies as well as with small/medium sized companies and has served in various capacities including Controller, Vice President, and President/CEO. Each week he will provide comprehensive information on the many aspects of buying/selling businesses.

We have been discussing ways in which businesses can be sold (asset or stock sale) and, in our last article, we discussed other factors of consideration when selling (e.g., valuations, resolution of outstanding issues, buyer down payments, etc). Today’s article continues with this theme and specifically deals with the issue of seller financing (and other deferred payment mechanisms).
One of the factors having a determinative effect on the sales price (and the probability of a sale) is the existence of/amount of owner financing. It is a very fortunate seller who receives all cash for his or her business and, generally speaking, this is an infrequent occurrence – maybe 10% of businesses sell without some type of seller financing and, of those, the majority sell with real property (land, building, etc) as part of the package. In addition to a note, a buyer may also insist upon paying the seller using other types of deferred payment arrangements – royalty fees, earn-outs, non compete agreements and/or consulting agreements, etc.
It is a perception in business circles that sellers who insist on all cash receive only 70% of their asking price whereas sellers who finance or partially finance receive 85-90% of their asking price. In order to obtain the maximum sales price and to “optimize saleability”, seller financing is critical. In addition, seller financing broadens the base of potential buyers, increases the probabilities of selling, and decreases the amount of time to sell the business.
Seller financing (and other deferred payments) comes with a downside however as the entire sales price is not received at closing (i.e., the portion(s) of the sales price which are deferred are paid to the seller over a period of time) and the seller is dependent upon the buyer to make these payments. Future payments to the seller may be dependent upon the success of the business the seller just sold and the success of the business is dependent upon the operating abilities, financial capabilities and the character/integrity of the new owner(s). As the majority of sellers of businesses are at an age where financial security is paramount, sellers must exercise due diligence in protecting themselves against the risks of deferred payments.
One critical factor for the seller is to deal only with qualified buyers. The buyer should have adequate capital and income as well as the requisite business experience. If possible (and this is difficult to accomplish at times, especially if bank financing is involved), the seller’s note and other deferred arrangements should be secured by the assets of the company; further, personal guarantees from the buyer (secured/collateralized by other assets of the buyer) should be required. Remember: this is your money and you want to do everything possible to ensure its receipt.
Any existing seller’s obligations (leases, lines of credit, rental guarantees, etc) which have been personally guaranteed by you should be transferred to the buyer/new owner and you, the seller, should be released from those obligations. In addition, for so long as the seller has financial compensation due from the buyer/new owner, certain financial requirements should be established as part of the structure of the arrangement. These could take the form of limitations on new owner’s and management’s compensation; maintenance of certain cash balances, inventory levels, etc; limitation on payment of dividends; etc.
Further, insurance policies (life and disability) should be placed on the new owner with the seller as the sole beneficiary. Additional restrictions may be limitations on the utilization of monies from the sale of assets and limitations regarding acquisitions and business expansions. All restrictions would be eliminated when the seller is paid in full and these limitations could be reduced over time also as the amounts owed the seller decreases. It should go without saying that the seller should receive financial statements (prepared by an outside party) on a regular and frequent basis until all amounts owed the seller are paid in full.
It in incumbent upon the seller to retain competent advisors who can assist and guide the seller in reducing his risk and/or ensuring the seller receives all that is due with the minimum of risk. Additionally, it is critical that the seller receive comprehensive tax advice to ensure the proper structuring of the sale so that “after tax” cash to the seller is maximized.
With the above being said, the precautions detailed above should not unduly hamper the new owners in the operation of the business. As with many things in life, you are trying to achieve a delicate balance – an equilibrium which maximizes cash and minimizes risk to the seller while at the same time minimizing restrictions to the buyer (in other words, a WIN/WIN for both parties). There is no way to eliminate all of the risk inherent in seller financing or other deferred payment plans. Safeguards are important but the new owners must be able to run the business the way they see fit.
As always, see you next time in this same space for our next article – the pros and cons of buying a business via an “asset” sale. As always, should you have any questions or require additional information please feel free to contact the R/ Fain Group at 832-646-0832 or via our web site.

To learn more about Ralph Fain, Tune into CNN 650 Sunday at noon.