As I send this, I’m in Las Vegas at the PaperSource
Note Convention.
It only seems natural that I should send out something
to do with notes (or debts.)
So, I’m happy to let you know that John, a student
from New York City, has sent me a list of questions about seller-financing
notes.
Listen as I go through John’s list of questions
concerning what happens when a business seller agrees to finance part of the
purchase price of a business.
Remember, if you want me to answer your questions just
send them in.(Add cash if you want to
skip to the top of the list 😉)
This week I'm asked what amount of vendor financing is ideal when doing a business transaction. Listen to me talk about the largest and smallest amounts I've seen done on deals.
Transcript:
It is David Barnett
once again and this week the question I received was is it normal when you buy
a business for the vendor to finance to 20% of the purchase price? Now I have
done other videos about vendor financing or vendor take back notes. And this is
the first time I have had a question about the normal level of financing that
we might expect for a seller to do. The reality is that the amount of financing
that a seller has to do relates to two things; number one
how quickly does the seller want to move the business? The biggest impediment
to selling a business is the access to financing. So, when I was a business
broker and I had sellers that wanted to sell a business very quickly. I would
advise them that if they were more willing to hold more paper on the deal or do
a bigger vendor take back. Then we would likely be able to sell the business
faster.
The second
consideration involved is how many and
what kind of tangible goods are included in this business sale? The amount of
tangible goods included in this business is going to determine what kind of
traditional or institutional bank financing that we are going to be
able to obtain. So, if there are hard assets in the business such as equipment,
machinery, vehicles etcetera. Then we are going to be able to bring a
traditional bank lender in; that means we are going to be able to get more
traditional financing. We don't have to ask the vendor for as much vendor
financing; now in the question it mentions 20% but in my experience I have seen
across the spectrum. Equipment intensive businesses where the buyer had lots of
money, the buyer was able to get bank financing. And basically asked for
10%-15% vendor financing just to give them a little bit more security and to
give them all the positive advantages that I talked about in other videos about
why you need to do a vendor take back when you are buying a business.
In other cases I have
had service oriented businesses without a lot of equipment and material and
they have sold with, I have had one that sold with 75% vendor financing. So,
quite literally the buyer put in 25% and the seller finance the balance. There
was even a period of time back after the financial crisis of 2009 were we did
several deals in my business broker shop, without any banks involved at all.
They were entirely deals with buyers and sellers where the buyer would put down
money, either from saving or perhaps from a personal debt tool like a line of
credit for example. They would put down their money and the vendor would
finance the balance; and most of those deals it was between 40%-60% vendor
financing, so there is no hard and fast rule when it comes to the amount of
vendor financing that you might expect in a deal. Basically,
it's completely up to negotiation and it is important that when you
are buying a business that you ask, ask for the world. They are just going to
say no, that is fine, that is part of negotiating.
And from the seller's
point of view offering a greater amount of vendor financing can help sell the
business more quickly. But more importantly, it can help you actually sell it
for a value closer to its true value. Because, the difficulty of course is
always getting financing for that goodwill component and no bank is
going to finance a 100% of the equipment for example. So the buyer needs to
have some equity to offset what the bank is going to give him and in order for
a seller to enjoy that last little bit of value to bring the price of the
transaction up to where it should be if it is a profitable business. The seller
has to be there to finance it, there is just no other place to get the cash and
I have often had sellers tell me that they didn't want to finance a buyer when
they sold their business.
And I advise them that,
quite frankly what would happen is because they weren't willing to finance
buyers wouldn't be able to put a deal together. The business would sit on the
market for years and years and eventually the seller would start to lower the
price to the point where they would end up with the same cash on closing as
they would have if they had sold years earlier and would have been willing to
accept some amount of vendor financing. So, it is really a win win tool for
both; it can help secure the buyers position, it can help offset some of the
risk by transferring it from the buyer to the seller. I have
explained that in other videos and really buyers should be asking for as much
vendor financing as they can get. And sellers should be using vendor financing
as a way to get the price that they are after.
Anyway, I hope that answers the
question and don't forget if you enjoy my videos and you like what I have to
say please share and like the videos that is how I grow my viewership and to
make sure that you always get the latest stuff that I put out. Be sure to put
yourself on my email list. I send out an email every week.
This week I answer Peter's question. How can I trust the information given by a business seller? Take a look.
If you're considering buying a business, you should sign up for my new online course; Business Buyer Advantage. Save $100 during the pre-sale period. Only $79.
I’m
back today with another viewer question.
Peter asks, ‘When buying a business, how do I trust the information
that’s provided from the seller?’ It’s a great question. I love the quote from Ronald Regan—Trust, then
verify.
The
first and best way to verify information is via third party sources. For example if you know that in the restaurant
trade that about 50% of sales are in the form of cash and 50% are in the form
of credit and debit cards, then you can check the credit and debit card
terminal statements and if it equals about half the sales being represented in
the financials then you know that the cash sales are probably being represented
fairly.
Another
example would be if you were going to buy a bar in a province or state where
all liquor has to be purchased from a state owned agency. You can get records directly from them that
will show what the purchases to the business have been over the course of the
year. If you know the average margin on the alcohol then you can work out what
the sale should be and compared that to what’s being represented in the
financial statements.
When
I was a business broker, I was always very clear with buyers that financial
statements are nothing more than ink on paper. Just a few days ago, in fact, I
was actually working on a business evaluation and the property taxes went down
every year over three years. I thought
that was kind of interesting, so I asked the business owner about it. He
explained that they paid the taxes monthly and that the bill hadn’t gone down,
they’d just been falling further and further behind.
In
this case what was being report in the financial statements was not the actual
property tax, but the amount that they had paid towards a property tax. That's not the correct way to do it at all.
The
full amount of each year’s bill should have appeared on the income statement
and any unpaid amounts should have been on the balance sheet as an outstanding
liability.
One
of the things you can look at when you're doing an investigation into a
business is look at what kind of financial statements that you're being
provided with. Accountants prepare three different kinds of
financial statements.
1.Notice
to Reader: This means that the accountant has taken the information provided by
the business owner and formatted it so that it looks like a set of financial
statements. That’s it literally.
2.Review
Engagement: Tthe accountant does some minor review of the information to make
sure that it makes sense and if something is obviously weird or out of place,
the accountant might
3.Audited: The accountant would actually come in and do
an investigation, look at numbers, etc.
Notice
to reader statements might cost somebody $1,200 or $1,500 to do. A review engagement might be $5,000, and the
audited could be $20,000. It’s very rare
to find a small business with audited financial statements.
Audited
statements are typically reserved for bigger entities or for some
not-for-profit & public entities who probably has some pretty simple financial. You’re not going to get an accountant to put
an auditor’s opinion on a small business like a restaurant or convenience store
without some very thorough investigation of what’s going on in the business. It’s
simply too risky to their professional reputation to be careless.
If
we can’t have full confidence in what the sellers giving to us for information,
what we have to do is work within the bounds of knowing that the information
may not be correct. The way that we protect ourselves in this situation
is through the structure of the deal.
What
that means is a vendor take back note or vendor financing of some portion of
the purchase. Let’s take for example a business that the buyer and seller have agreed
is worth $100,000.
Let’s
say it’s a small restaurant or corner store and the value of the assets within
the business is $60,000. This represents
the inventory, the equipment, etc. The things that we can actually put our hand
on or what we call ‘tangible assets.’ This means the other $40,000 would be
considered ‘goodwill.’
On
the other side of the equation we have our source of funds and it also has to
add up to $100,000. You go to the bank
and the bank is willing to lend you 75% of the tangible asset value of $60,000,
that means a loan of $45,000.
Next,
you’re going to put in some money of your own.
Let's say that you’re going to put in another $30,000, which brings us
up to $75,000.
The
offer that you make to the seller is on closing day I will provide you with
$75,000, but I want you to finance $25,000.
We call this the vendor note. It is also called the vendor take back or the seller
financing.
At
the closing table when you buy this business, there are going to be several
contracts all made up. There is going to be, perhaps, a non-compete agreement,
a bill of sale for the tangible assets and the good will, assignments of leases
for equipment or an assignment for a lease of the premises.
One
of those documents is actually going to be the note. That debt instrument representing
the vendor financing, also called a promissory
note. It’s going to say, ‘I, Mr.
buyer owe you, Mr. seller $25,000 and I’ll make payments of $XX each month
inclusive of XX% interest over XX years, etc.’
You
need to be sure that this note contains a clause saying ‘subject to offset in
the case of material misrepresentation or undiscovered leans.’ What that means
is that if it turns out after you bought the business that the seller had been
lying to you about information then you can say to him, ‘you misrepresented
yourself.’
‘There
is a material misrepresentation of the facts. I'm not going to pay you.’
You’re
already in the possession of the business. If you stop the payments he has to:
1. Go find a lawyer, if he wants to fight you
2.Pay
the lawyer a retainer
3.Take
you to court and prove that he gave you the proper information so you owe him
the money.
If
you didn't have the vendor financing and you bought the business and you paid
the full $100,000 in cash. What would happen when you discovered the
misrepresentation is:
1.You
would have to hire a lawyer
2.Pay
the lawyer a retainer
3.Find
the seller
4.Take
him to court
5.Hope
that he hadn’t spent all the money
6.Get
a judgment en
7.Have
the problem of trying to collect
So
what we are doing with the vendor financing strategy is we move the
responsibility and the risks associated with lying from the buyer and move it to
the seller.
Now
the seller e has an incentive to make sure that he gives you the proper
information and that he doesn't lie to you.
He needs you to be successful in
the business in order to collect that outstanding vendor financing.
If
you make a proposal like this to someone and they flat-out refuse to do any
vendor financing it can mean one of a couple of different things.
1.It
can mean that he knows he's lying or misrepresenting something, so he's not
willing to take the risk of not being paid that portion of the money –or-
2.He
doesn't think you have the ability to run the business. If he doesn’t think you
can run the business, he knows he is going to have trouble collecting that
money because you won't have the profits to be able to pay him.
Both
of those reasons are an excellent, excellent reason not to proceed with the
purchase.
If
you want to learn more about how to buy and sell businesses you should be
visiting my blog site, www.InvestLocalBook.com
, but you should also be signing up for my online course Business Buyer Advantage.
http://gumroad.com/l/czUIi
To
be sure and not miss out on any of my informative articles and videos about
local investing, small business and buying and selling businesses, sign up for
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I tell the story of a shrewd negotiator who got both a higher price and a retirement income by understanding how to structure a win-win deal with a buyer.
Learn more about notes and local private business deals by reading Invest Local.
Well, I've put the finishing touches on my Business Buyer Success! program for the fall.
This program uses my Business Buyer Secrets seminar information and breaks it down into small digestible parts, gives you homework and tasks to accomplish and then a one-on-one follow up with me to review.
We then meet back and share among the group to maximize our learning of the material.
During the course, you will conduct a business search, meet professionals that you will use in a purchase and make an offer on a business.
This is your opportunity to arm yourself with the information you need to buy a profitable, mature business and pay the right price while mitigating risk through a proper deal structure.
The whole thing kicks off on September 2 and will finish just before Christmas.
I walk you through the program and give additional information in this video
Special pricing offer ends August 2, 2014. If you want to change your life through business ownership, this is the program for you. Program open to US and Canadian residents, pricing in $CAD.
My session on Wednesday with a group of newly arrived immigrants was a full day of 'Business Buyer Secrets.' One of the biggest secrets in buying a business is how to manage risk by using vendor financing.
I recorded a video with a few thoughts and an explanation of how this works.
Let me know what you think. Again, more info next week about my online version of 'Business Buyer Secrets' which will be mixed with one-on-one and group coaching.
