Question: Your last article “What to consider when buying a business” was quite informative. My problem is how best to finance the purchase when I have limited resources. What are my options?
Answer: There is no easy answer to your question. Working with start-up business clients for more than eleven years has shown that individuals with poor credit and little or no savings have a difficult time securing adequate financing.
Commercial lenders are conservative by nature. They need to feel confident you will be able to repay the loans and that the assets or collateral can be liquidated in case of default.
If your intent is to buy an existing business, one option would be to look for owners who are willing to finance all or part of the selling price.
In my experience most small business owners give little thought to an exit strategy until faced with declining health, loss of key personnel, or declining sales. If theirs is a service business, versus one that sells a product, banks have a difficult time assessing the value of “good will.” In most instances the owner will have to take back a note for all or part of the sales price.
If you do find what looks to be a viable business for sale, with seller financing, you still need to do the due diligence outlined in my previous article. The odds of finding an owner who will finance 100% of the purchase price has low probability. But if you do find one, be cautious.
Once you and the seller have agreed on a price, after each has completed an evaluation by a competent third party, the next step is to determine the method of financing. If the seller insists on a fixed price do not agree unless it is offered at a discount to its intrinsic value.
A safer method would be to negotiate an “earn-out agreement.” Essentially, an earn-out is a risk-allocation vehicle, where part of the purchase price is deferred over a specific period of time. It can provide an incentive for the seller to assume a short term, predefined role in the operation of the business, and help ensure continued growth and customer retention.
The reason earn-outs are used is simple. They can bridge the gap between the seller, who wants the highest possible valuation, and the buyer, who may be willing to pay top dollar, but only if the seller achieves certain performance metrics, defined as EBITDA or earnings before interest, taxes, depreciation and amortization.
Gray Poehler is a volunteer with SCORE Naples. Business counseling on this and other business matters is available, without charge, from the Naples Chapter of SCORE. Call (239) 430-0081 or visit https://naples.score.org/content/find-mentor-165 The SCORE business office is located at 900 Goodlette Road North, in the Fifth Third branch bank building. Office hours are 9 a.m. to noon, Monday through Friday.