Last week we covered a range of different approaches to designing a handover method in order to aid negotiations using terms of sale. If you missed that article click here for Part 1. This week we’ll be looking at some of the more complicated ways of pushing business sales through. A word of caution though; these next options if mismanaged, can be riskier to the seller, though as with last week’s article, if a price cannot be agreed upon they should be worth considering if the alternative is losing the sale.
2. Vendor Finance
As indicated by the monthly survey, finance is becoming increasingly difficult to obtain. The result of this is that many business sales that should have gone through are now failing because the buyer cannot fund the purchase. One possible solution for this is vendor finance whereby the business seller can provide finance to the buyer with a repayment plan. Usually this is no more than 30% of the business price. Though the seller will often remain a part owner of the business, they generally will not be participating in the profits.
The big advantage of this approach is that it removes the financial hurdle for prospective business buyers. By taking it out of the equation, the seller effectively widen their pool of buyers considerably by making it easier to buy. In a have now, pay later society it sets you apart from the rest. The downside is that it is riskier to the seller, can take a long time finalise, and if the contracts aren’t prepared properly can leave either party open to legal issues. Because of this the seller will charge an interest rate of 2% higher than the current commercial interest and wherever possible, the lent money should ideally be floated against the equipment value in the event that the business takes a downturn.
This solution can be used for businesses of any size, though it should only be considered when absolutely necessary. If you’ve found yourself in a position where vendor finance might have to be used it is absolutely vital that both buyers and sellers have their solicitors construct an airtight contract.
Earn-outs are generally reserved for businesses of bigger consideration. Though earn-outs have their similarities to vendor finance they are not necessarily designed to circumvent the issues with raising finance. More so, they are designed with two things in mind.
a) To reduce the risk to the purchaser by redistributing it both purchaser and seller
b) To allow the vendor to maximise the business sales price by carrying some of the risk themselves
So how does it work? In instances where there is high uncertainty regarding the businesses future performance, business owner and buyer agree upon a discounted sales price under the proviso that the amount discounted be settled when certain conditions are met. These conditions are usually related to contracts or profits. Under these circumstances a risky element to the business that would have otherwise lost the sale or resulted in a substantial drop in asking price can now be used as a bargaining chip.
For example, a business makes a $200,000 profit from a yearly contract but this contract is never assured. A buyer perceives this risk and asks for an equal reduction in the asking price. The owner knows that this contract will be renewed, refuses to drop the price and we have a stalemate. Generally, when a business is sold, all risks associated with the business are sold along with it. An earn-out dictates that the seller maintains some degree of risk after the sale. So in this instance the seller could agree to a $100,000 reduction in the asking price on the provision that when the contract is renewed the remaining $100,000 be paid out by the buyer. So rather than force the buyer to swallow a $200,000 risk, both parties now share the risk equally.
This example is just one of many ways that a business earn-out can be structured, meaning that it can cater to a businesses individual needs and situation. The downside to an earn-out is that though the seller does not retain a share in the businesses, they are inevitably tied to the success or non-success of the business. The situation proposed by an earn-out is also ripe for breeding distrust and can often result in relations going sour between buyer and seller. As with vendor finance it is absolutely essential that both parties involved have their solicitors design an airtight contract with all bases and outcomes covered. Earn-outs are complicated and time consuming, but if managed correctly can allow the buyer to alleviate risk, and the seller to maximise the selling value over an extended period of time.
As we covered at the beginning, not all of these approaches may be applicable to your business. For the most part, a well-designed handover could be all that you need to get your business over the line and in many cases, the difficulties involved in a vendor finance or earn-out situation make them more trouble than they are worth. In today’s climate however as the distance between the seller’s lowest price and the buyer’s top price becomes harder to reconcile they are more frequently being utilised as solutions to otherwise unsolvable problems.
The main thing that should be taken from all of these solutions is that there is always a way to get a business across the line. Negotiations should therefore be approached with a problem-solving and positive attitude. It’s a little extra time at the end, but in the scheme of things, if having the business change hands for the best price possible is the goal, it will definitely be worth it.
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Disclaimer: All information in this article is for information purposes only. It should not be taken as financial, legal or any other advice. Individual circumstances of businesses and business owners may vary and have not been taken into consideration in this article. Always seek independent legal and financial advice for any matters regarding business sales.