Selling a business – Why not all cash?

November 25, 2009

I meet with prospective business sellers routinely.  We get chatting about the value of the business.  They give me the materials to value their business.  I come back with a proposal, a likely formula might be terms of 1/3 down by the buyer and the seller finances 2/3.  Two of three sellers then say, “Oh, I won’t sell my business and finance the buyer.  I must have all cash.”

The usual concern is that a new buyer will drive the business into the ground and the seller will then, to ensure having something from the business, run the business again or selling off the assets.  This article from business week http://www.businessweek.com/smallbiz/news/coladvice/ask/sa990930.htm , in trying to understand businesses failing after being sold, speaks to business failure rates in general. “When failure was defined as bankruptcy, however, the number dropped to less than 1% annually. About 4% of the businesses that closed their doors each year “failed to make a go of it.” And owners disposed of about 2% of businesses annually to prevent further loss.  The authors concluded that cumulatively 64.2% of the businesses failed in a 10-year period — if failure was measured as discontinuance of ownership — but only 5.3% actually filed for bankruptcy during a decade.”  And this article http://blog.globalbx.com/2008/10/06/small-business-statistics-and-failure-rates/ suggests that the highest failure rates are in businesses that are non-employer, free lancers and the like.  Each of these articles suggest that the risk of the business failing is small, though not negligable.   Other articles suggest that a clear understanding of the numbers that fail and why is not really known.

Regardless, the fact is that there are a number of good reasons for the seller to finance a transaction:

1)  Tax implications for the seller are improved when the transaction is completed over a period of years.

2)  All cash transactions are usually discounted 15 – 20%.  The seller earns less from the transaction.

3)  Most buyers with a sum of money they are able to put into a business want to maximize the return.  Their return is usually greater with the larger business purchased.  So, if they can put all of their money down on a “right” business and finance the balance they will ultimately do better than putting all of their money on the total price of a “right” business for sale for less.

4)  By requiring all cash, some good business operators will be eliminated from the buyer pool because their resources are not great enough.

5)  Buyers want the seller in the deal to give assurance that what was portrayed as a viable business is indeed and that the seller is willing to help, as agreed, when various hurdles come up.

6)  Bank financing may not be a possibility, especially now when their regulations have stiffened on financing businesses.  Many banks and SBA can require sellers to carry some of the debt in the transaction.

In many cases not carrying paper, financing the transaction, can make or break actually selling the business.

 

 

 

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