Buying a business: choosing a business part 2

Seller financing is a gate you want open on your road to business success

Seller financing is a gate you want open on your road to business success

Seller financing is a gate you want open on your road to business success.

You may have made it past all the other checkpoints, but if you’re unable to secure financing for the business you want to buy, your journey ends here.

In part one, we looked at 13 areas of consideration in determining what makes one business more valuable than another:  location, assets, inventory, products and services, trained employees, existing customer base, established suppliers, competition, the industry, existing cash flow, financial records, systems and procedures.

Let’s pick up where we left off.

What you are going to do with the business after the sale has a direct relationship to your perceived value of the business. If you can develop a realistic plan of action to improve the business after your acquisition your likelihood of success improves considerably.

However, none of that matters if you can’t get the financing you need to buy the business in the first place.

The truth about bank loans

It is a common misconception that banks will provide loans for small business acquisitions. In fact they do not.

If an acquisition is structured as an asset purchase it may be possible to obtain a loan under the Canada Small Business Financing Program (CSBFP) under which banks can provide financing up to a percentage of the appraised value of furniture, fixtures, and equipment (FF and E). The percentage of financing available varies from 75% to 90% of the value of the FF and E depending on the bank.

The downside is that the seller is unable to take advantage of the $750,000 capital gain lifetime exemption and the allocation of purchase price to market value of furniture, fixtures and equipment triggers a recapture of depreciation and a capital gain. This is unattractive to sellers and will result in a higher purchase price.

Business Development Canada (BDC) is another source of acquisition financing however they typically base the financing on the reported cash flow and do not finance restaurants or retail businesses. Their interest rates are high and they typically insist that the seller financing be subordinate to theirs and remain unpaid until their loan has been retired. This is unacceptable to most sellers.

The result is that neither program works very well.

Look to seller financing

When the seller is willing to finance a significant portion of the sale both parties win. The buyer has more confidence in the information provided and in the business knowing that the seller has sufficient confidence to lend.

The interest rates charged by sellers are generally lower than elsewhere and in today’s market range from 5% to 7%.

The seller’s note typically has a right of offset protecting the purchaser against fraud and misrepresentation. It also protects the purchaser against claims related to operation of the business prior to their acquisition.

Seller-provided financing typically ranges from 20% to 50% of the purchase price. This enables a share sale resulting in lower taxes for the seller and the financing may increase what a purchaser is willing to pay. The purchaser realizes lower risk, better terms and a greater commitment of the seller to ensure the purchaser’s success.

Personally I would not buy any business if the seller was not prepared to finance at least 20% of the purchase price.

Earn-outs, another form of seller financing, base a portion of the valuation on actual future performance. They can be used to bridge the gap between a buyer’s perception of the future and risk and the seller’s perception of the same. While they reduce a purchaser’s risk and provide incentive for the seller to make sure the purchaser has success, earn-outs may in fact increase the cost of the business should it prove very successful.

The availability of seller-provided financing and the considerations we described in part one are all factors in the value of any given business on the market.

But in the end, your choice of business should come down to one final, individual factor—whether or not you can you see yourself in the business.

A common trait amongst successful business owners is a passion for their business—either for what their business does i.e. provide a product or service or  for the work of building and operating a successful business. So if this business or the next isn’t exciting your passion, it’s time to look at another opportunity, keeping in mind that “there is no perfect business.”

Learn what you can from observation, from the documentation your business broker provides, from meetings and discussion with the business owner and from your industry and market research. In the end, you will make the choice. You will never have all of the information you would like to have in order to make an informed choice but will conclude that all things considered “this business might work for me”.

For further information visit www.sunbeltcanada.com or contact one of the experienced business brokers at our offices across Canada.

GET MORE TIPS on buying, building or selling a business.  Subscribe to our monthly Sunbelt Canada newsletter. Each issue has helpful tips for prospective and current business owners as well as a small business success story.

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One response to “Buying a business: choosing a business part 2

  1. Pingback: Canada’s small businesses are worthy of respect AND funding | The Real Deal

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