Financing the sale of a business, part 2

Earn-outs can put more money in the seller's pocket

In the last post, we talked about financing the purchase of a business through a bank loan (unlikely), through a Canada Small Business Loan (CSBL), a hybrid structure using a CSBL, and a seller note (preferred choice).  Today we’ll explore other approaches.

Business Development Canada (BDC) provides a lending facility—albeit expensive–for business acquisitions. There is a bureaucracy to work through, but BDC does finance some sales. They generally require the seller to finance some of the transaction behind their loan and the seller doesn’t usually receive principle payments on his/her note until the BDC debt is repaid.  Most sellers aren’t willing to wait that long to get paid out, and being behind the bank adds to their risk.

Selling assets of the business to a leasing company then leasing them back is another approach that can provide additional cash to the seller at closing.

Partnerships where the purchaser has an option to acquire the rest of the business in time are sometimes used, but these can be fraught with problems.

Earn-outs

Earn-outs can be a rewarding way for sellers to get around many issues

A seller and purchaser may disagree over projected earnings or other factors affecting the value of the business. Historical financial information may not be enough to offset the perceived risk to a purchaser determining a purchase price. An earn-out that bases a portion of the valuation on actual future performance can soften the risk of speculative projections to the purchaser and put more money in the seller’s pocket.

Financing the sale of a business: part 1

Financing the sale of a business with or without the bank

There is a general misconception about the availability of financing for the purchase/sale of a small business, especially where the purchase price includes significant goodwill:  banks do not want to finance these transactions.

Your banker may play golf with you and suggest that their bank would be happy to provide financing for you at any time.  A good client for many years, you assume that when you are purchasing a business for $100,000, or for $3,000,000, you could structure the deal with 30% cash from you, a 20% loan from the seller and 50% from your bank.

Think again.  Your bank was willing to lend you money while you had a steady income, but in lending for the purchase of a business the bank fears its security is insufficient.  If the business fails you have no income to service the debt and the assets of a failed business have questionable value to the bank.  They do not know how to and do not intend to run the business.  In a bankruptcy sale the assets may go for 10 cents on the dollar.

Your bank may be willing to give you a home equity loan or a loan against other assets to cover part of the down payment.  They may agree to process a Canada Small Business Loan (CSBL), but it will be limited to 75% to 90% of the value of Furniture Fixtures and Equipment with an upper limit of $350,000.  If real estate is part of the transaction, the upper limit is $500,000.  You must provide a Certified Appraisal of the assets. Sunbelt has Certified Machinery and Equipment Appraisers (CMEAs) on staff and can provide the appraisal for you.

The catch–the loan must be for the purchase of assets, not shares.  The first problem is that the tangible assets may represent a small part of the purchase price. The second problem is that the seller will likely end up paying more tax. There will typically be a recapture of depreciation, which is taxable as corporate income and a taxable capital gain on the sale.  As a result, the seller ends up with less money.

There are two ways to offset this. 

Doing business in Brazil

Sunbelt is opening four offices in the São Paolo area of Brazil

There’s a positive can-do energy about Brazil and its people I really like. And as a business person, it’s refreshing to deal with individuals who know what they want and aren’t afraid to make decisions on the spot.

I recently spent two weeks in São Paolo training new Sunbelt franchises. We’re opening four offices here, one in Rio de Janeiro and another in southern Brazil. We anticipate two more before Christmas and another 20 next year.

With its hustle and bustle and quick pace of decision making, São Paulo, the seventh largest metropolitan area in the world, is much like Manhattan. There’s a difference, though, in how those decisions are relayed to you. The Brazilian “no” is much more polite.

Brazil itself is an emerging world power.  It’s the world’s 10th largest economy (in terms of GDP) and the World Bank projects it will be 5th in a few decades.  The Economist lists it as the worlds fifth largest both by geographical area and population (198.7 million). Some 83.5% of its people live in urban areas.

This was my second trip to Brazil and I was amazed at the similarities in small business between our two countries. Since quality education is not freely available in Brazil, there is more class distinction than in Canada, but both countries are welcoming of immigrants and have a thriving small business sector that drives the economy.

On the downside, banks in both countries are reluctant to lend money to finance small business acquisitions and it’s hard for small businesses to get credit and the loans they need. Taxes in both our countries are very high with government expenditures growing faster than the economy and requiring an ever-increasing share of the average person’s income. We have governments that do not understand or promote small business and in fact implement policies that restrict their growth. The level of support is much greater in the United States.

Infrastructure and security are still issues in some areas of Brazil; on the plus side of the ledger, labour is inexpensive and subcontracting and outsourcing have not been tapped. Big business in agriculture, mining, oil and manufacturing has always been here, but as opportunities arise for the average Brazilian, millions are emerging from poverty, becoming employed and first-time consumers with income supporting a growing small business sector. The middle class now represents nearly 50 per cent of their population.

You couldn’t help but feel positive about the entrepreneurial spirit at work in São Paolo. Brazilians are clearly proud of their country’s economic growth and looking to the coming years with great anticipation. They are excited about hosting the 2016 Olympics and the 2014 World Cup and the opportunity to show the world their welcoming nature and the vast improvements in the country. We at Sunbelt are also proud that we’ll be a part of it.

Sunbelt® is the world’s largest network of franchised business brokerage offices.  Because each office is independently owned and operated, Sunbelt’s global reach is balanced with intensive knowledge of and involvement in the business communities in which it operates.

Can you afford to buy a business?

Can you afford to buy a business?

Six weeks ago you lost your job.  So far, all your leads have been dead ends and you’re starting to get nervous.  You did get a package, but it’s not going to last forever.

Maybe it’s time to go into business for yourself, provide your own job security and income. The thought of it gets your pulse racing. You’ve got a strong work ethic, a positive outlook, experience in leading a team, and hey,  if the stress and pressure of your last job didn’t get to you, nothing will.  You start researching and the more you read about it, the more it appeals to you. You find out there’s a much higher rate of success based on buying an established business compared to starting one:

• starting a brand new business, 35% are successful
• buying a new franchise, 80 to 85% are successful
• buying an existing business that has shown profit for three years, greater than 98% are successful

Maybe you’ve been thinking along the same lines, but unlike the individual in the above scenario, you don’t have a severance package—you’re still working and you’ve only got $20,000 put aside. You have a line of credit with your bank that you could draw on, though.  Should you even consider it?

How much would you need to put down? How much would you need in total?

First, some perspective on buying a small business* in North America:

• 90% of buyers will have to finance the purchase price of a business;
• 90% of buyers will have to get the sellers to finance part of the purchase price;
• 90% of buyers have from $50,000 - $150,000 that they are willing to risk or spend investing in a business.

*all uses of “businesses” here refer to companies with fewer than 10 employees, and less than $3 million in sales.

Negotiating the down payment

In negotiating a business deal there are many things that are important, but none more so than the price and terms.  Businesses tend to sell for two to three times what the business makes. Another part of the price and terms is the all-important down payment.  The down payment should never take a buyer right out of cash. They will need some working capital to keep the business going, even though an existing business should have an immediate cash flow. Buyers should always keep something aside for the unexpected.  And if they’re intending to add improvements, that too, should factored in.

Although the seller always wants more down payment and the buyer always would like a smaller down payment, somewhere in between is a fair deal that will work for both parties.

Keep in mind, too, that negotiating the right deal takes time and effort, typically some three to nine months, and in the meantime you’ll still need to pay for your groceries and other family expenses.