Photo by Giorgio Trovato on Unsplash
A famous line around the office comes from an Andy Cavanaugh seller meeting some years ago. The seller owned a bar and told Andy, “I don’t feel the need to involve the IRS in my cash business.” Leaving aside the ethics behind such a statement, the main practical issue is that such a business is not bankable, i.e. eligible for a bank loan. It implies that nothing is really reliable, because if you’re willing to lie to the government, what else are you being dishonest about? Can the books be trusted to be clean? What about issues with past employees? Possible legal issues?
In this particular case, seller financing often blows up. Even if the seller finances 100% of the deal, the mindset and mentality that led to the creation of a non-bankable business means the proper systems and culture aren’t in place for a handover, and not only does the buyer suffer from this, but potentially, the buyer cannot successfully operate the business, and the seller ends up not getting paid either.
Good Seller Financing
A rising interest rate environment can often lead to more seller financing in the marketplace. As we’ve discussed before, banks look at cash flow, working capital, owner salary, and debt service. With a higher interest rate, the debt service number increases, and sometimes that means deals are harder to come by.
We’ve been around for a while now, so we have seen rising interest rate environments and even frozen markets. In the 2008-2009-2010 period, many banks wouldn’t even return phone calls as entire sectors like housing and construction were ruled “off limits.” There was a six-month period where there was really only one bank we managed to work with.
During that time period we still saw businesses sold, but that was due to sellers willing to be creative. Some were willing to finance up to 30% of the deal, which changed the calculus for banks who now saw significant de-risking of the deal as well as the seller’s own confidence, exemplified by his/her willingness to risk more of the sale price.
Even better, in some of these situations, the business was solid enough to allow buyers to collect a couple years of their own operating history and go back to restructure the deal, which often resulted in a balloon payment to the seller who had pitched in to make the deal happen and some of that remaining debt packaged into a new loan with a bank now confident in a history that didn’t previously exist.
That two-year history is vital for bank lending and is often the reason seller financing often comes to the rescue with “emergency” financing. In these cases a buyer may have recently bought a franchise business but something (e.g. a family emergency) means they have to leave the state and cannot continue to operate the business. Sometimes the franchisor cannot help facilitate a sale and the bank can’t offer a standard loan without more history. In these cases a significant portion, even up to 100% of the purchase price, is often lent by the seller.
Whatever type of financing you need to buy a business or whatever type you feel you might need to offer to sell your business, we are here to help. Reach out today.