Its almost 9 PM and you’ve got just one more order to fill because you promised “Henry” you’d have his order ready for pick up first thing tomorrow, Henry’s an old customer, a good friend and has a machine down and the part we stock will have him up and going again. But the nagging thought comes back again….”after 27 years I don’t need this anymore, I’m gonna sell it!”
There are many different reasons why businesses are sold. But of all the reasons, the three most popular are retirement, burn out and major illness.
When you own a business and have fought the battle over the years, the time does come when you’re ready to cash in the business and turn it over to someone else. You’ve built your dream, watched it grow and it has taken good care of you. Finally you’ve talked to your family, your CPA and your attorney and decide to do it. You place your business on the market!
About a year and a half later, after negotiating with two individual buyers and two corporations, you do the deal with “Pete,” the nice guy from Cincinnati. Pete seems to be a good person, has a nice family and the proper background for the business. You’ve structured the deal with a good down payment and have agreed to finance the balance with interest over a seven year period. Sweet deal, right? Well, maybe.
After working with hundreds of business owners over twenty plus years and hearing all their stories, one precaution comes shining through the excitement of a sale! If owner financing is going to be a part of the deal . . . be very careful! It might come back to sting you. Especially if you plan to retire after the sale.
Typical “Sell The Business Scenario”:
Here’s why. Take the case of an owner we’ll call Jack Stokes. Jack had his tire business for almost 30 years. He and his wife are in their 60’s and both are in good health. They have two sons and a daughter that are grown and gone. The daughter teaches, the older son is an attorney in a nearby town and the younger son is finishing up his accounting degree. He wants to be a CPA with his own practice. None of his kids want anything to do with tires or the business. Selling tires isn’t easy. The kids grew up in the business and their “big plan” was to go to school, get a degree and go their own way. And so it is.
But the business has been good for the Stokes. It paid for their house in town, their condo at the beach . . . and the note on the business real estate was paid off two years ago. So now with the business sold they can settle back, take it easy and enjoy their grandchildren.
A beautiful picture but let’s look at reality. Jack’s deal with Pete from Cincinnati is based on a 30% down payment and there could be some major problems down the road. Let’s see why.
Details Of The Deal:
After lengthy negotiating, the final price for the business was $380,000. The price included the building and land, shop and office equipment, all 4 vehicles and the complete inventory. Pete will provide a down payment of $125,000, leaving a balance to be financed (by owner Jack) over seven years at 10% interest. The owner was not looking for an “all cash” deal in view of tax implications. After calculating the finance balance of $255,000, the monthly payment for the new owner comes to $4,233. And that monthly payment doesn’t seem that bad since tire sales and shop service have been steady and growing.
How Sellers Get Hurt:
But . . . what if something goes amiss, say, 2 1/2 years into the payback period of the seller’s loan? Like an economic or regional downturn, or losing one or more of the business’s name brand tire lines, or one or two key shop people? These are problems that can have a direct bearing on cash flow and the ability of the new owner to service the debt. And if after several months of missing some or all of the loan payments and the loan goes into default, guess what? The original owner, Jack, may get the business back. And Jack most likely will not want it back for various reasons.
Legally, the original owner will retain title on the business and assets until the balance to be paid has been satisfied. But from the time the new owner took over, the inventory may be depleted, the shop equipment abused, some of the employees may have left and the bank account emptied. Who would want it back!
When Owner Financing – Be Wary:
So what is the admonition or lesson here? If you plan to provide the financing when selling your business, proceed with extreme caution. Before entering into any purchase or buy/sell agreement, its best to break down the price of the business into several scenarios of down payment and the amount to be financed, so you can take an advance look at what the typical monthly payment may be for the new owner.
As a general rule, the larger the down payment, the lower the risk of downstream payment problems. And during the “high anxiety” period of ownership transfer, knowing the debt service risk has been fully considered and is hopefully minimal, is knowledge that can be of real comfort to the present owner.