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Deal Terms Can Increase The Sale Price Of A Business

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It is normal for an owner contemplating the sale of their business to want all cash or nearly all cash for their business. This is certainly understandable on the part of a selling business owner in order to minimize the risk of the buyer defaulting.  However, an all cash purchase is not a realistic expectation in today’s privately-held business for sale marketplace.  Equally important, an all or mostly cash deal will not enable a business owner to get fair market value for the business. There are several compelling reasons why business owners should consider some level of seller financing when it comes to selling a business, not the least of which is an increased selling price.  As this article will highlight, studies have shown some interesting results for obtaining a higher selling price based on the amount of seller financing involved.

 

The most common deal structure for small businesses and lower middle market businesses in today’s market is a combination of cash down payment, a seller’s note and many times an earn-out note. An acquisition where the buyer uses SBA financing comes close to an all cash deal from the seller’s perspective but it has been well documented that SBA loans are very difficult to get done in today’s market except under the most ideal of conditions involving a highly profitable business and a highly qualified buyer. Even then, the selling price must be validated by a 3^rd party appraisal which may or may not agree with the buyer and sellers opinion of value.

 

There are a several reasons why a business is highly unlikely to be purchased for all cash. The first is because the business marketplace is full of businesses for sale where the seller will carry financing and requires a partial cash down payment of 50% or less. All things being equal, any prudent buyer would buy the business that requires a lower down payment when compared to a comparable business with similar sales and income but a higher down payment. Seller financing allows a buyer to pay off the note using income from the business rather than personal funds. Perhaps just as important, a seller willing to finance a portion of the sale provides a strong indication that the seller stands behind the ability of the business to pay the seller back while providing the buyer some assurance that the owner has not misrepresented the business. 

 

Another important advantage to seller financing is the ability to defer the capital gains tax on a portion of the sale price. The impact of capital gains tax has resulted in several of our clients in the past changing the deal structure to reduce their tax liability. Of course, you should consult your accountant to review the tax implications of any deal structure.

 

The third compelling reason for a seller to consider seller financing when selling a business is the ability to get the highest price possible. Seller financing allows a buyer to leverage the purchase of a business and deploy financial resources toward working capital and capital expenditures to help grow the business. As a result of these factors and the reduced risk to the buyer, the buyer will usually be willing to negotiate a higher price compared to a deal structure with a higher down payment.

 

The following figures are from a book by Mr. Toby Tatum called Transaction Patterns that demonstrate the increased value to a seller when using seller financing. The

figures are based on data from a database called BizComps, which consists of thousands of sold business transactions.

 

Comparison of Financed versus All-Cash Transactions

Avg. Price multiple of earnings for financed transactions - 2.15

Avg. Price multiple of earnings for all cash transactions   - 1.84

 

As you can see, the average selling price with financing was approximately 17 percent higher than the average selling price for the all cash transaction. The deals financed in the results above had an average down payment of 37 percent.  The difference in the selling price becomes even more pronounced if we compare the all cash transactions to financed transactions with seller financing of 70% or more.

 

Comparison of Seller Financing of 70% Plus versus All Cash Transactions

Avg. Price multiple of earnings for financed transactions - 2.31

Avg. Price multiple of earnings for all cash transactions   - 1.84

 

In these financed sales, with 30 percent or less given as a down payment, the average selling price was approximately 26 percent higher than the selling price for the all cash transactions.  For example, a $1 million dollar all cash business sale could equate to an additional $260,000 for an owner willing to carry seller financing. Said another way, an owner would have to discount the price of a business on average about 26% to receive all cash and even then it might not be marketable. Of course these are averages and the actual figures for any specific business will depend on the particulars of that business but the main point is to illustrate the potential value and advantages of seller financing when selling a business.