Option One: if the seller of the business has created intellectual property or some proprietary idea that they don’t wish to sell as part of the business transfer, but the buyer needs that knowledge or invention in the business, the seller and buyer can enter into a licensing agreement. The buyer would pay an agreed fee as a royalty.

Option Two: Another means of a seller receiving payment from the buyer of the business can be via Consulting Agreements. These would be constructed according to what works for both parties but provides a way of maintaining the continuity of knowledge the seller has from owning and operating the business while the buyer acquires that knowledge.

Option Three: If the owner of the business wishes to sell because they have arrived at retirement age but the seller has children working in the business, part of the purchase price negotiations could be the buyer extending a Family Employment Guarantee. This meets the need of the seller because they don’t have to worry about their children no longer being able to work in the business and it comes with a payment the seller is comfortable accepting.

Option Four: Two important benefits to most business owners are health insurance and life insurance. Health insurance coverage; especially for business owners with a pre-existing illness means they cannot readily change their health insurance policy to another company. Negotiating the purchase price where the buyer will continue to allow the seller to keep the same policy and pay for it can be a great benefit and relief to the seller. Life insurance and indeed other forms of insurance can be handled in the same manner.

Option Five: One of the advantages of being an entrepreneur is that you can claim expenses that an employee is unable to claim. Membership at the best golf course in town, driving the latest model car, an annual vacation to Lake Tahoe and other perks sometimes become necessities for some entrepreneurs. Structuring the sale of a business to continue the sellers ‘perks’ can be an appealing option; even if it’s only for a year or two.

Seller finance does not have to be restricted to purely a seller note on the transaction. A seller can be used to receiving many business ‘perks’ they have enjoyed from owning and operating their business. Allowing the seller to continue enjoying those ‘perks’ can be a good strategy when buying a business.

Option One: Allow the buyer to assume the sellers credit. Both parties need to be clear on their roles and responsibilities, but if the buyer is able to run the business and continue to buy all inventory or other items the seller always bought and paid so they earn a high credit rating, this can make the transition of the business easier to the buyer. If this method of financing is considered, an agreement should include a separate indemnification clause between the seller and the buyer making the debt the ultimate responsibility of the buyer. Using a good attorney is best to prepare this legal document.

Option Two: A similar idea to the one above but of the buyer assuming the sellers credit, the buyer is allowed to assume capital notes and leases. The seller is allowing his good credit to again be exposed to future decisions of the buyer, but can help the buyer to build their credit worthiness.

Option Three: A popular approach where the seller of the business has conceived an idea or the business would experience strong growth by either a capital injection from a buyer or merging with a much strong business is an earn out. An earn out basically is an agreement that the seller will receive a portion of the sale price based on the sales or profit achievements of the business in the future. This can be attractive to both parties where it is clear the business will grow once the buyer and seller come together. Some buyers like to use an earn out as an incentive to the seller to make sure the business transitions cleanly to the buyer. This can be difficult to negotiate; especially if the seller has little to no control over the buyer and the operation of their business and its employees.

Option Four: If a business has a large amount of inventory that the seller owns outright, the use of a consignment sale for this part of the transaction may be useful. Under this scenario, the seller retains title to the inventory but allows the buyer to sell it in the business and pay the seller for the inventory as it gets sold. This saves the buyer having to get inventory from other businesses while it allows the seller to get his money from the inventory and be exposed to the market.

Option Five: A very common option when selling a business that also includes real estate owned by the seller is for the buyer to lease the real estate from the seller for a period of time and have the first right of refusal to buy the real estate if at some point the seller wishes to sell.
Seller finance does not have to be restricted to purely a seller note on the transaction. A seller can be used to receiving many business ‘perks’ they have enjoyed from owning and operating their business. Allowing the seller to continue enjoying those ‘perks’ can be a good strategy when buying a business.

So the good old days are now behind us with the banks now preferring the buyer to bring a down payment of 20 per cent, the seller to carry a note of 20 per cent and the banks will then fund 60 per cent as long as the seller moves into second position.

This change of dynamics is making it difficult for sellers to decide if they really want to sell.  Many sellers are reluctant to carry a note because they are worried the buyer will not make that payment to them or the conditions of the loan may mean the seller does not start to get paid until 3 or 4 years after the transaction closes escrow.

There are down sides to seller finance but there are many upsides.  Let’s have a look at a few of them.

One of the main benefits to the seller agreeing to carry seller finance is that it delays the payment of taxes.  Selling a business at the close of escrow triggers a taxable event.  However, the tax is only due and payable when the seller receives the money.  For example, if the seller carries a note on $100,000 of the purchase price and the note is repaid at $20,000 per year for five years then the tax due is not paid until the seller receives the money each year.  And the rate of tax is based on the applicable tax rate in that year; not the rate the seller paid when the business closed escrow.

A further benefit to the seller from seller finance is that the note provides a steady stream of income in the form of an annuity.  For many sellers this is attractive as they may be moving to their next venture and are yet to create a new steady stream of income.

Another benefit of seller finance is that it encourages the buyer that the seller believes in the business and all the disclosures that have been made and that the buyer has the ability to run the business effectively.  This morale boost can be important to buyers as they work through their decision making process.

In addition to the above, seller finance will generally pay interest on the seller note at a much higher rate that the seller can get by investing the money in a CD or some other form of interest bearing account.

When you bring all the above ideas together there is a compelling reason for the seller to fully understand Seller finance and how it would benefit the sale of a business.  In some cases, a seller may choose to get a sizeable down payment from a qualified buyer and then carry a note for the rest of the purchase price.  Of course, if a seller was comfortable with this situation it would enable the deal to close escrow much quicker as the buyer does not need to apply to a third party lender for finance which can often be a 6 to 12 week process; if the loan request is approved.  At the moment, knowing a third party lender will approve a loan request is one of the biggest drawbacks affecting the closing of many business transactions.

The SBA 7(A) program helps small entrepreneurs start or expand their businesses with loans through bank and non-bank lending institutions. Previously the loans only allowed a maximum of $250,000 in intangibles (including goodwill) to be financed. However, under the revised rules, it is now possible to finance any amount of goodwill (even up to this program’s lending limit of $2,000,000), as long as at least 25 percent equity exists in borrower down payment and/or seller stand-by financing.

There is more good news, in that the SBA has temporarily increased its guarantee from 75 percent to 90 percent of the total loan amount, and currently waives the guarantee fee (2.6 percent of the loan amount) charged to borrowers.
For buyers and sellers of a business that want to use an SBA 7(A) loan, it is important to keep in mind that each bank will likely have their own criteria and means it is necessary to contact your bank to determine its specific approach. Some good talking points to help you though include:

1. Cash flow. Remember, SBA loans are cash flow loans, that is, the business must be generating a positive cash flow. Each bank will assess the company’s loan repayment ability using the Debt Service Coverage Ratio (cash available for debt service divided by cash required for debt service). Banks will usually deny a loan if revenues have declined in recent years, although they may make an exception if the company can demonstrate a current stabilization or growth trend.
2. Buyer downpayment. In general terms, a lender will want to see the buyer provide about 20 percent down payment to buy the business. A buyer could then finance the remaining 80% with a combination of the seller carrying a note of say 15% and bank finance of 65%. The buyer downpayment could come from sources such as family gifts, a tax-free rollover of a 401(k) or IRA, or home equity line of credit (as long as the buyer has an additional, unrelated income stream large enough to feasibly pay off the debt). A bank may also accept a seller’s note on full standby, which means the seller agrees to forgo any payments until the senior bank debt gets paid in full.
3. Buyer management expertise. The lender will expect a potential buyer to have extensive and relevant ownership or management experience. In 2007 the SBA did some research to see why businesses were failing with an SBA loan and they found one of the main reasons was a lack of management experience in the industry the business was operating. The lender may waive this in the case of an established franchise, as long as the company is not in the hotel/motel, restaurant, or construction industry.
4. Collateral. The requirement for collateral varies with a bank as does any specific minimum coverage. However, where it is available helps the buyer’s loan application position. Most lenders also favor deals where real estate is available.
5. Buyer credit and legal history. A FICO score of at least 650 is typically required and often higher, that is, 680. A buyer also needs to have a relatively clear legal history.
6. Loan amounts. Although the SBA currently limits loan amounts to $2,000,000 for non-real estate transactions (and up to $5,000,000 for 100 percent real estate deals), it is possible to combine SBA financing with other payment options to accommodate proposals with larger financing requirements. For instance, you can use current asset-based lending or seller financing for this purpose.

 The temporary provisions may only extend through the end of 2010, but Congress is expected to raise the overall guarantee limit to $5,000,000 (with up to a 90 percent guarantee.) In addition, the SBA 504 program limits for 100 percent real estate transactions may increase to $14,000,000.

Additionally, consider making a list of the current liabilities of the business and against that list, note whether it will expire when the business changes ownership, stays with the seller or will transfer to the buyer. Also, a better idea is to completely remove any personal or special items that will not be sold as part of business. This removes any ambiguity and becomes one less tension point in the transaction.

Once this is done, one of the first steps to selling the business is to get an appraisal on the business as a going concern. If you’re the owner of the business you may have an opinion about what the assets are worth but that opinion will not be acceptable to a genuine buyer. The best approach is to have a third party perform the appraisal for you.

There are a number of reasons to use a third party appraisal and these include that it provides confidence about the value of the business and the asking price. It provides an informed opinion about the business value so the seller can decide if the asking price will be enough for them to sell the business. Most sellers think their business is worth more so the valuation keeps the seller real with his price expectations and hopefully won’t take the business to market if they are not going to get a price that works for them. A business valuation also helps the seller see the business strength and weaknesses from a third party’s perspective and understand their tax situation. That is, the price the seller gets when he closes escrow doesn’t mean they get to put all that money in their pocket. The IRS wants their tax piece from the business sale and the business valuation helps informs the seller.

Another two reasons for a business valuation is that it puts one less strain on the transaction. There are often many deal points between the buyer and seller in a transaction. The more deal points and the more tension in the transaction the greater the chances it will not close escrow. As price is normally one of the biggest items, having a reasonable purchase price eliminates any tension and allows the focus to move to the terms and conditions of the sale. Also, if the business transaction requires the buyer to obtain third-party finance, the business valuation will help all parties work through that scenario. Some lenders will require their own appraisal that they order; others will work with the third party appraiser if the skills and certifications of the appraiser meet their standards as well as the quality of the appraisal.

Some final good reasons for an appraisal are that it also helps and gives confidence to the buyer about the business and any advisers the buyer chooses to use. The buyer is always the most nervous party in the transaction as they have the most to lose personally, financially and professionally. The greater their confidence the more likely they are to continue with their inquiry. Sellers forget that buyers have many options including just saying no and not buying a business. If you are a business buyer and you find two businesses that are of interest to you and one has done a valuation and one hasn’t; which do you think would be more attractive to make further inquiries about? Same question but instead of being the buyer, put your feet in the shoes of a lender. A buyer brings you two businesses they want to buy and need a loan with one having a business valuation and one not, which business do you think the lender will spend more time considering for a loan?

A business valuation is an important aid to all parties in the transaction. A business valuation normally refers to the appraisal of a business as a going concern. If the business includes real estate, this would be appraised separately from the business. If the business is not currently profitable, it can still have value if that value is couched in the assets of the business such as fixtures, furniture and equipment and /or inventory. To appraise these assets a Machinery and Equipment Appraisal would be used; not a business appraisal.

An appraisal is a great asset to a business transaction. There is cost and time required to put the proper document together but this should far outweigh not getting this done.

One of your first starting points is to be clear exactly what is being sold. This may seem obvious but many Sellers think they will deal with it when they get an offer. So let’s break this down and look a little more closely at it.

The two most important things to a buyer when looking to acquire a business, is current cash flow and the potential of the business. From the buyer’s perspective, the cash flow is the fuel that feeds the business to pay the suppliers, employees, landlord, tax man, lenders and of course, leave something left over for them after all their work and capital investment in the business.

For the buyer to achieve the above, they need to purchase all the assets of the business so they understand what each asset does and how it contributes to the cash flow and/or potential of the business. As the seller of the business, it’s therefore important that you make it clear what those assets are and present them in the best possible light.

So if you are thinking of selling your business, your immediate response to this question may have been “I am selling the business as a going concern on an ‘as is’ basis.” This is perfectly fair. But you need to do a little better than that. And I’ll explain why at the end.

So we are agreed the business is being sold. When you have your first buyer meeting at the business, the buyer will be absorbed in processing what they can see and assume they will buy with their purchase of your business. The first thing to do is therefore remove any items that are not part of the purchase price. If you have collectibles such as paintings, antique cars or items that are personal to you and not needed to make the cash flow of the business, remove these now.

If the business has inventory, make sure the inventory is fresh and as usable as possible. If a buyer sees a lot of old inventory with doubtful value, it will become a specific negotiating point in the transaction and may kill the deal. If time is on your side, start selling the inventory to your customers even if it needs to be at a reduced price. You are likely to get more from your customers than being forced to sell it as a discount as part of the purchase price to the buyer.

The next thing to do is make a list of all the Fixtures, Furniture and Equipment. Hopefully this list is already in place as your accountant would be using this list as the depreciation schedule for your tax return. If the list doesn’t exist, now’s the time to build it as when you close escrow upon selling the business this list will be required. If the list is old, now is a good time to update it by making sure you still have everything and it is in good working order and condition. If it can no longer be found, remove it from your list and talk to your accountant about writing it off for tax purposes. If it’s still on the list but it no longer works, sell it or get rid of it to make the presentation of the business better and allow the items that are working and in good order stand out to the buyer.

If your business has Works In Progress, make sure you can easily arrive at a value for those items. It will become a negotiating point in the transaction.

If the business has excess fixtures, furniture and equipment, turn those items into cash by selling them. There are plenty of options to selling the goods including eBay and Craigslist. Make sure what is being sold is as presentable as possible but again, get some cash into the business and move unwanted items. This could include vehicles and real estate and other excess items. Hopefully the business has a current list of fixtures, furniture and equipment. If a list doesn’t exist, there is your starting point as you may be surprised what you have stored away.

After the above has been played out as much as possible and the motivation is still not strong enough to keep the business open, it may be worthwhile considering selling the business with the assets that are in place and needed to run the business. For example, if the business is a restaurant or has a lot of assets built in such as a manufacturing plant, there may be value in selling the business on an “as is” basis to a buyer who will take what you have, bring some fresh capital and enthusiasm and move forward with what you have. If your business owes money to a landlord, this may also be a method to “pay” the landlord and get out of your lease.

If this is an option that makes sense to you, your best way of handling this situation is by getting a third party valuation on the machinery and equipment. A third party appraiser who is properly trained and certified can you give a written report showing the total value of the assets. You can then use this report to negotiate with other parties and settle some or all liabilities. The appraisal method used may be Fair Market Value but it could also be Fair Market Value In Continued Use. Fair Market Value In Continued Use recognizes that the equipment may have shipping costs to get to the business, may have expert labor to install and get the equipment operational, and to remove and transport the item would incur costs thereby affecting its value.

As the saying goes – beauty is in the eye of the beholder. Where assets of a business are concerned, such as inventory, machinery and equipment, prices fluctuate based on supply and demand. If the supply and demand gets too far out of balance then prices move accordingly. That is, if the supply increases it means that prices decrease and vice versa. This is influenced by one final component and that is time. If the seller wants to move quickly then the price will go down. If the seller is in no hurry to sell and the buyer wants to move quickly, the price will go up.

First, it’s rarely as simple as closing the door and handing the key back to the landlord. If your business has a lease you obviously need to discuss the situation with the landlord. If you have a good relationship and feel you can handle it on your own to save hiring help, take care as you handle the issue. Bear in mind the landlord is no different to you. They lease the real estate to make money. If you close the doors, they need to find a replacement for you which may take time to achieve. This can be a talking point with the landlord as you may be able to bring a tenant to replace you. If this is the case, make sure this is correct as the landlord may become frustrated if the person changes their mind. Similarly, the landlord is not required to accept the person you bring so be aware the landlord has options.

Second, and this is the main reason for this article, some businesses are cash poor and so are struggling to keep their doors open. That is, they are unable to generate enough sales to produce the profit that allows them to keep their doors open. However, some of these businesses are rich in assets. If this is the case, a real option is to manage down the assets to either keep the business going or get the best price possible for the assets. Here are some suggested strategies.

If the business has a lot of excess inventory but limited cash, move the excess inventory. This means going through each piece of inventory to make sure it’s in good condition. If its condition is questionable, discount it but get it sold. Better to have a few dollars in the business and free up some space than have it sit around and collect dust. This is especially true if the business is paying to store any inventory as costs can be reduced by eliminating unnecessary storage space.

Most buyers are interested in two things when buying a business; cash flow to service debt and provide an income to sustain the buyer’s lifestyle and potential. Buyers are not excited about buying a business and managing it down to a smaller business. If you own a business that is challenged by cash flow and limited potential, your buyer may be someone in the industry who is looking to add the assets of your business to their business and therefore take you out as a competitor. These buyers can be harder to find and they are almost always only motivated by paying as low a price as possible.

The first option is to take a real assessment of where you are at. One of the best ways of doing this is to talk with your accountant. Make sure your accountant is not simply filing your tax return to meet compliance but actually helps you look behind the numbers and understand how your business is performing.
What do you need to know?

Most business owners understand their gross sales. Some are adept at using this number to explain the success of their business. For example, have you spoken to a business owner that said “Sales are up 20% on this time last year.” They say this with great pride but that doesn’t tell the full story.
Some business owners can tell you the net profit of the business. Net profit is simply what they pay taxes on or gross sales less cost of goods less expenses. Some business owners like to say “Our bottom line was up 10% compared to last year.” This is good news but that doesn’t tell the full story.

A few business owners can get into their financial statements and understand what’s happening in their business. For this business owner it’s the Profit and Loss Statement. If they prepare this document themselves they know what’s going on, but most business owners have a resource such as a family member or at least a book-keeper to handle these details for them. However, that leads to a couple of points. The first point is that theft in small businesses, due to the recession, is at its highest in many years as the person handling the books is able to cook the books by stealing funds which the owner doesn’t know about. They can steal funds through a false invoice or buying certain goods, have the business pay for them and then take the goods back and get a refund and keep the money. There are many creative ways for someone to find money if they want to. So how does a business owner protect themselves? One of the ways is for the business owner to do a line by line check of the profit and loss statement at least on a monthly basis. Any item that appears and the owner can’t remember what the expense was for can be challenged to find an acceptable answer. It can then be wise to do random tests to make sure all expenses can be verified such as checking to make sure that new computer the sales person needed is still around or that special order of inventory was needed and did arrive etc. Testing the monthly profit and loss followed up with random checks creates good discipline and helps the owner stay on top of the critical aspect of the business but this doesn’t tell the full story of the financial health of the business.

The health of the business is really revealed by working with the Profit and Loss Statement and the owner that can read and understand the Balance Sheet. The balance sheet is the place that explains how the money coming into and going out of the business was used. It shows what’s owed and it shows what the business owns (or the assets of the business). It reveals the owner draw and investments and basic information about the Accounts Receivables and Accounts Payable and how they are tracking. If Accounts Receivables are growing then Accounts Payable may also grow but they should keep their ratio’s consistent.
If a business owner can understand a healthy balance sheet they are well on their way to maintaining and growing a successful business. Understanding a balance sheet doesn’t mean you need to become a CPA. It means you need to ask questions until you “get it.” Most business owners shy away from understanding the balance sheet as it’s too confusing. However, if you ask the same question month after month it will eventually makes sense.

The first area to look at is the financial statements of the business.  The first and most readily used is the Profit and Loss Statement as it shows the income and expenses of the business with hopefully the income greater than the expenses.  Just as important, however, is the Balance Sheet as this document shows the wealth of the business.  With an up to date profit and loss statement and balance sheet, a trained business appraiser can then calculate what the owner of the business could expect to get if they decided to sell it on the market.

In addition to the financial statements, the next performance area to measure and manage can be simple business metrics that include the number of incoming calls to the business (and this can be broken down into times of day if call volume is an important metric,) the number of hits to the website, volume of email, volume of faxes and volume of orders placed on-line (if important.)  Depending on the business, the total number of orders placed and/or the number of orders placed by each sales person.  In simple terms, sales can generally be easily measured.   It’s important that the sales team is clear on sales targets and agree how they are to be measured.  Sales people are motivated by getting results.  Make sure the results are measured accurately, consistently and fairly or sales people will become de-motivated; which is obviously the complete opposite from what you want to do.  It’s important to start by building Key Performance Metrics for your business.  Don’t be afraid to change and add other metrics as they are normally easy to isolate and therefore count.

Make sure all metrics are counted monthly and as many data points shared with everyone in the business as possible.  Celebrate successes and ask the team for suggestions when the performance isn’t acceptable.

The next aspect to a Performance Plan for the business and something not always done is an annual performance review.  There are different approaches to this topic; some are personal preference.  For example, some businesses tend to link the annual performance review to also a salary review.  My preferred strategy is not to link them.  My reason for this is that I don’t think they are linked.  Compensating someone on performance is important.  However, the good performance of one person does not always mean the business can afford to pay as collectively the business may not be performing well enough.  The argument goes that incentives should include as many workers as possible so if they are successful so too will the business, but you can have a top performing employee that is bring in the best sales for the business but his demeanor or attitude to co-workers may not be acceptable.  Therefore, how do you financially reward a top performer during a meeting and then point out behavior or communication problems.  Rewarding people for sales is great however, you will lose any goodwill from acknowledging and rewarding great sales and then bringing up negative issues.

If the performance of each employee is measured with an Annual Performance Review an extension of that is to include feedback from the co-workers at the same level as the employee.  This is called a Peer performance review.  It can be controversial as someone may choose to denigrate the performance of a co-worker they don’t like.  So there are risks.  However, it can provide constructive results if managed correctly.

A best practice for a Performance Review is asking an employee that reports to a manager their opinion on the performance of the manager and how the manager could do things better.  This is called a Management Review.  Once again this approach can have a downside but it can enable a business to grow and be internally stronger if open and honest communication is part of the business culture.

The final item to consider is your performance as the business owner.  Not every owner has the time or desire to put such a process in place, but if you want your business to grow and have a healthy business environment I think it’s one of the best means to enhance the success of the business.  Depending on the size of the business, the Owner Performance Review can be done by hiring an outside consultant.   An alternative suggestion is to do it by anonymous survey but this approach reduces the effectiveness as it restricts the answers that can be given and doesn’t allow an exchange to clarify things.

There is a business axiom that says “If you can’t measure it, you can’t manage it.”  The Performance of a business can mean the difference between success and failure.  Most businesses do not fail overnight.  They decline gradually, with often the decline picking up steam towards the end.  A good Performance Plan will provide warnings that if measured and managed will allow corrective action to be taken in time.

Part 11 of this article series, explains the importance of a Disaster Recovery Plan.  Most businesses don’t have the time to put this together.  That can be a mistake and this article explains why.