exits bbby Dyanne Ross-Hanson

Seller financing not to be feared when planning firm’s sale Size does matter when it comes • Typical buyers for companies quisition for businesses with to designing an exit strategy for your valued at $1 million or lower less than $1M in annual revenue. business. were dominated by individual, • For companies valued between Buyer demographics, valuation many first-time, buyers. Strategic $500,000 and $2 million, nearly multiples, completed transactions, buyers and private equity groups, one out of five buyers required financing structure and available typically well-funded, represent- the seller to accept some portion are just some of the variables that dif- ed the vast majority of buyers for of their payment in the form of a ferentiate “Main Street” companies, companies valued at $5 million or seller’s note receivable. defined as those with a value up to $2 higher. million, from “Lower Middle Market” • The smaller the deal, the more While seller financing comes with companies, defined as those with a likely it terminated without many pros and cons, understanding the value between $2 million and $50 mil- successful completion. Only 26 most common design, terms and protec- lion. percent of companies valued tive measures is the focus of this article. According to the International Busi- at $500,000 or less successfully ness Brokers Association (IBBA) and closed. This increased to almost Skin in the game M&A Source, in partnership with the 99 percent successfully closing, In today’s marketplace, most small- Pepperdine University, their latest once the company reached $5 business sales are financed, either Market Pulse Survey Report indicated million or greater in market value. through third-party financing or seller a number of obvious, and not so obvi- • While lenders have increased financing or some combination of the ous, conclusions. They included: their appetite for lending, they two. Most institutional lenders have two are far less likely to finance ac- basic requirements before proving to be

1 Once a price 2 This often repre- certain period of health and/or tips has been agreed sents a range of 10 time. commercial market upon, the first to 25 percent of the rates. step is typically to purchase price. 4 While terms require the buyer to can be flexible, it is provide some sort 3 The balance of typically suggested of skin in the game the purchase price that the interest in the form of an is then structured rate be based upon out-of-pocket down as an interest- your buyer’s payment. bearing note, for a history, financial

8 A Seen in upsize june • july 2015 reprinted with permission, all rights reserved www.upsizemag.com exits Bb

“The more attractive and self-sufficient the business, the less likely the seller will need to finance the majority of the deal.” Dyanne Ross-Hanson, Exit Planning Strategies

a viable financing option. One, they need tory, financial health and/or commercial mercial real estate or investments that confidence in the borrower’s ability to market rates. Duration is typically 5 to 7 can provide more security. Lastly, the repay the . And two, they need col- years, but with amortization calculated seller could require the buyer to secure lateral to sell, if the borrower does not over a much longer period, such as 20+ a life insurance policy naming the seller or cannot pay back the loan. years to make payments manageable. as beneficiary. That way, should the If your buyer is internal, such as fam- At the end of the loan period, it is buyer meet an untimely demise, the ily members, co-owners or key employ- expected the buyer will make a bal- loan will be paid off in full. ees, their leadership experience and loon payment equal to the outstanding Finally, it is important for the buyer qualified collateral is typically limited. principal amount owed. The idea is, at and seller to avoid the tendency to If a seller is motivated to close a deal that point, the business should be on do it themselves when designing and and has confidence in his/her successor’s solid ground and financing should documenting this arrangement or any ability to run the business and credit be easier to secure. other exit strategy for that matter. history, he/she often facilitates the It is also important to note, however, Buyers and sellers should each involve transaction by agreeing to finance some that the terms of the note should reflect their independent legal and accounting portion of the sales price. the buyer’s ability to make payments advisers, at minimum, when ironing out What percentage of the price is typi- based upon realistic business cash flow the details. cally seller financed? Much depends projections. After all, if the new owner Accountants are needed to offer valu- upon the strength of the business’s cash cannot manage note payments, plus ex- ation opinion, review/recast financials, flow, finances, operational efficiencies, tract a livable wage, the sellers are likely and review tax implications of the deal customer diversity, forecasts, seller to find themselves unintentionally back structure. Attorneys will draft the legal dependence, etc. The more attractive in the driver’s seat. documents necessary to formalize the and self-sufficient the business, the less arrangement including a purchase likely the seller will need to finance the Safeguards to consider agreement (the terms of the busi- majority of the deal. Some transaction What about protective measures ness sale), a promissory note (the loan intermediaries cite 60 to 70 percent of for seller financed deals? There are a document) and a securities agreement the sales price as typical in their seller number to consider. First is incorporat- (which describes what and how the financed deals. ing provisions so if note payments are lender can access collateral). Once a price has been agreed upon, missed for 60 to 90 days, as an example, Yes, the size of your business, be it the first step is typically to require the the seller has the right to take back Main Street or Lower Middle Market, buyer to provide some sort of skin in the control of the business. The seller might often does dictate feasible exit strate- game in the form of an out-of-pocket also restrict the buyer’s sale of assets, gies to consider, and may involve seller down payment. This often represents a acquisitions and expansions until the financing as part of the deal structure. range of 10 to 25 percent of the pur- note is paid off. Don’t be afraid of it, but do be aware chase price. The balance of the purchase Some sellers require the buyer to of it, when contemplating exit plan op- price is then structured as an inter- make a personal guarantee on the loan, tions. est- bearing note, for a certain period of or require the buyer to put up a personal time. While terms can be flexible, it is residence as additional collateral (as- typically suggested that the suming there is significant equity in the be based upon your buyer’s credit his- home). Some buyers have other com-

Contact: Dyanne Ross-Hanson is president/founder of Exit Planning Strategies, a firm dedicated to assisting owners of privately owned businesses develop exit and transition strategies: 651.426.0848; [email protected]; www.exitplanstrategies.com. www.upsizemag.com as seen in upsize june • july 2015 reprinted with permission, all rights reserved 9