For most people, a house is the biggest purchase they will ever make. But for those with a penchant for entrepreneurship, purchasing a business can be an even greater investment. If you are interested in how you can get started, read another article we wrote on how to purchase a business . In addition to being one of the biggest purchases you can make, it can also be one of the most risky. However, there are lots of tools and strategies you can implement to protect yourself and turn a potential risk into a most rewarding endeavor.
When working with buyers, we find that their number one concern is almost always with the valuation of the business. If you are putting all of this time and money on the line, you want to know that you’re getting what you pay for. Specifically, you want to know that the return on your investment is what you are led to believe it will be. Additionally, there’s a big concern of being consistent with the former owner’s successful protocols and procedures to maintain the current business cash flows. Of course, there are other reservations a buyer may have , but we’ll discuss those in another blog.
The truth is the REAL numbers don’t lie. The financials are the primary source of information we have to analyze when we value a business. But what if the numbers you get to see do lie? Or what if they are embellished? You don’t want to shell out extra dollars because the seller’s numbers aren’t true for whatever reason. It is ultimately up to you, the buyer, to determine if purchasing the business is viable. So, what can we do to try and mitigate these risks as much as possible?
There are a lot of strategies and tools available to a buyer in a business transaction, but I have three favorites that are simple and used in our practice all the time.
First, seller financing is a great tool whenever a buyer cannot acquire traditional financing from a bank or other financial institution. Seller financing is when a seller will only require a percentage of the purchase price as a down payment and will take the remainder in a promissory note or a legal promise to pay the rest over time, in other words. In most cases, seller notes are paid over time with interest. However, they are great because whether or not the seller gets paid for the remainder of the purchase price may very well be dependent on your success as the new owner. Depending on the legal terms in the promissory note , the seller may have a vested interest in your success.
For example, you purchase a business for $300,000 and you paid $100,000 as a down payment. The deal is structured so that you will pay the remaining $200,000 to the seller over a 5 year period. If the business fails, the seller might not get that $200,000. Many times in this scenario, the seller will be able to take the business back. However, the seller sold their business because they no longer wanted it. Furthermore, if the buyer has driven the business into the ground, it will be far less valuable to the seller now. They may never get the business back to where it was when they sold it and they may not even be able to sell it again. In short, sellers typically don’t want to take the business back.
Another great strategy for a buyer that may be less-experienced in the industry they are entering into is retaining the seller as a consultant or employee that will stay on to help the new owner operate the business. Many times, a savvy buyer or business broker can negotiate several weeks to months of free training from the seller. However, most sellers will want to be paid for their time when it’s a longer arrangement, which can be anywhere from several months to years. It’s all negotiable.
A strategy that is less common but very effective in the business brokerage industry is the use of an earn-out provision. This is great specifically for when the concern is that the numbers might not be reliable or sustainable. When used, there is usually a cash flow floor set and if the business doesn’t cash flow at that minimum number, the purchase price will be lowered accordingly. A confident seller can negotiate this as well to work in their favor with a set cash flow ceiling, whereby if the business exceeded a certain cash flow, the purchase price would actually increase. In many cases, this provision is used in tandem with seller financing.
All of these are great tools that are at a buyer’s disposal. Of course there are many more that are used, but these are my favorite three. Another great tidbit is that many times you can implement more than one of these strategies in your business acquisition. And, a lot of the time, it makes sense to use these strategies in unison with other strategies to create an even stronger safety net for yourself. At Apex Brokerage we have vast knowledge and experience in business brokerage and a legal team in-house that drafts our contracts and provides their expertise to you to greatly enhance the likelihood of your financial success. If you are looking to buy or sell your business, we offer a free consultation in person or on a video call to help you understand how you can safely and successfully purchase a business. Call us today to get started!