Let’s talk about financing a business you’re thinking of buying/selling. How many people are walking around with all the cash needed to buy the business they found? Even if they have it – how many of them would put that much cash into a deal and leave them that much short in case of personal emergencies or at the least – having money available for the future needs of the business e.g. a “rainy day fund”, working capital or additional investment. Even when you think you have enough cash – more is often needed. When the Broker tells a Buyer the business is selling for $75,000 plus inventory he/she is usually asked “…how much inventory is there…” Seldom is he/she asked “ …how much working capital do I need when I take over? Remember most of the time you are buying the assets of the business – and they don’t include the Owner’s checkbook. The Buyer’s banker, his accountant or advisor will sooner or later tell him about this and all of sudden another +/- $10,000 is needed to put together the deal. (helpful hint: the amount many advisors tell their clients to have available at the time of purchase is least 2 – 3 times the average monthly expenses of the business – some businesses even more!).
What does all this mean – most people won’t use all their available cash to buy a business. There are also financial reasons why a Buyer won’t use a lot of cash for their initial investment – ROI, leverage or just plain risk (in case something goes wrong they want a cushion or in case of Owner Financing they think they can stick it to the Seller).
Hopefully I’ve shown that when buying a business – financing it is not an option – it’s a necessity. I didn’t even mention that more prospects will be available to buy any particular business. For example why should a Buyer take $100,000 and pay all cash for a business when he could take that same $100,000 and buy a business worth +/- $400,000 that could be financed!
Now with all this being said – how many businesses out there can be financed? How many have tax returns that can justify to a banker, investor, mom & dad or even the Buyer that the business can afford debt service (payback) along with a salary for the Buyer? I’ll answer for you – few. In fact most businesses can’t justify even being bought from what is found on the tax returns. If what I said is correct – and it is – why talk about trying to get financing from any of these sources? (Actually in a future article I will) So the only thing left is financing from the Owner. As a matter of fact, if someone is selling a business and won’t finance it – that Owner will probably wait a long time before finding someone willing to buy – and when/if he does – he will probably have to discount the fair selling price (not the asking price) more than 25% – 35%.
There are other reasons why a Seller should (and must) finance his business. Some are financial – additional money (interest), possible lower taxes on the sale and of course proof to a Buyer that you think your business is strong enough that you will even finance it. This is called by a lot of bankers – “putting your own fat in the deal” – and this goes a long way in their decision to finance the bulk of the sale. More next time…