In the past 9 years of brokering businesses for sale, I’ve found that almost 100% of the buyers closing on one of our listings have at one time or another completed the purchase of at least one real estate property, usually a primary residence. Perhaps that’s not surprising due to the fact the average Business buyer at our firm is between 45-55 years old, by that age, many people are already on their 2nd or 3rd primary residence.
We find this experience of buying and financing personal residences to be helpful as buyers move to the financing stage of buying a business. As a former mortgage broker, helping to educate buyers on their many options for structuring a deal is an important element to getting a transaction done with their business acquisition lender. We try to instill confidence in buyers that financing a business is very similar to purchasing a home.
The majority of businesses we sell at our firm are financed with a combination of a bank loan, the buyers down-payment or equity injection and in most transactions, a secondary loan from the Seller of the business. This second loan provided by the Seller in the form of a “Seller Note” is similar in some ways to a HELOC or home equity line of credit that homeowners commonly use when they put less than 20% down on a home.
Let’s break down the three components of structuring a business sale;
Bank Loan - The bank loan, the primary vehicle used to buy a business, will almost always be an SBA 7A loan from a local banker. The lender in underwriting the purchase, will need to have enough cash flow or SDE, generated by the underlying business being purchased, to cover payments for the loan. The math will be similar to a home purchase where the bank will keep their loan amount around 75-80% of the purchase price. Keep in mind that the cash flow or as we like to say SDE (Seller’s Discretionary Earnings) needs to be greater than $150,000 or more. I will explain what happens to those deals under $150,000 of SDE in another article. Terms are competitive but it pays to check with 2-3 lenders and get Term Sheets before picking a Bank.
Buyers Down - Payment - Buyers must come to the table with a minimum of 10% of the purchase price but ideally they have the 20% available in either savings, retirement plans or IRA’s or real estate equity. It helps tremendously if there is a working spouse as any household bills or monthly obligations like mortgage payments, school tuition, car payments and other installments can be supported by the secondary income from outside the business.
Seller Notes - Whenever we get the initial letter of intent from a Buyer, I almost immediately look for the amount of Seller Financing a Buyer is asking the Seller to kick in on the deal.
All of the business brokers at Playbook Advisory are used to telling clients that they must be ready to finance a portion of the deal for Buyers. There are many great reasons why business sales have Seller Notes. But almost always we hear why Sellers would rather not finance even a $1 of a deal. Obviously, there is a risk of getting paid out from this note. With lenders increasingly requiring full standby (No Payments) for up to 5-7 years. Sellers are quite nervous that this portion will not get paid.
It’s important that prospective buyers start talking with lenders and their business brokers early on regarding how they are planning on paying for a business. With your prior experience of buying a home, it doesn’t have to be too complex or daunting. Don’t be afraid to ask your banker for guidance on the different options available and compare notes so you get the best possible structure.
Jim Peddle
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