Walking the Tightrope—How to Navigate Financing Options
Do you remember going to the circus and watching the tightrope walker cautiously gliding across the sky? Their long pole slightly waivered as they went, but it helped them keep their balance and successfully get to the finish line.
This image often comes to mind whenever a client gets to the financing stage of the deal. The whole affair is a balancing act.
On the one hand, the buyer wants to reduce risk and put as little money down as possible. On the other hand, the seller wants as much cash up front as possible. Each of these demands threatens to sway that long pole and send the entire affair tumbling down.
As for the tightrope walker? Well that’s me and my team at Exit Consulting Group. We walk the negotiating tightrope, working to keep the two sides balanced and get the deal across the finishing line. From structuring terms to evaluating risk to addressing cash at closing to securing assets, there are various aspects threatening our balance as we go across the rope.
So with this balancing act in mind, how do you approach the financing options?
The first option to enter the arena is conventional financing. In short, this is a bank loan. There’s just one catch: the majority of banks won’t touch a business loan. They are in the business of writing loans for cars, homes, and the occasional HELOC (Home Equity Line of Credit). What do all these loans have in common? If you default on one, such as a vehicle loan, they can seize your assets. Walking into the risk-infused circle of purchasing a business isn’t their style. If a business goes under, there isn’t anything tangible they can seize to cover their losses.
In order to address that, the bank will want the buyer to put up personal assets, such as a home, as collateral. For business deals that span upwards of millions of dollars, a $300k-$600k home doesn’t quite cut it.
That’s why the Small Business Administration (SBA) stepped up to the plate. This government office guarantees a portion of select business loans as a measure to keep the economic engines of the country running. A government-backed guarantee lowers the risk for the bank writing the loan.
Now be advised, just like any government program there is a laundry list of rules, regulations, and terms. Any business going the conventional financing route will need to become very familiar with all the nuances of SBA loans. Additionally, many businesses don’t qualify, including cannabis companies, political enterprises, and Internet organizations.
From the seller perspective, a fully financed deal is as good as cash. Unfortunately, it’s not a sure bet. Between credit history, business viability, and the individuals writing the loan, there are a lot of variables to navigate to get a loan approved.
Even with the SBA loan, the buyer will likely need to put up some form of collateral or security. This is where buyers get cold feet. They question whether or not they want to bet the house on a business endeavor.
The next act will introduce seller financing. Here the seller carries the note while the buyer steps into the role of CEO. From a risk-o-meter, this one sways heavy in the way of the seller. Not only is the seller handing over the keys to their largest asset, they are expected to wait years for payments.
Let’s look at 100% seller financing. From the buyer’s seat, this is a great deal. It comes as close as possible to ensuring that the business performs moving forward, otherwise the seller loses their shirt on the deal. As you can tell, the seller should be getting anxiety attacks. To balance the scales, we encourage owners to skip the 100% financing model. Few good things can come out of that dynamic.
Hence the balancing act. We need to strike a deal that balances the risks between the two parties.
Insert the negotiation phase. For starters, sellers carrying the note will likely require more money upfront. After all, they have more to lose in this equation. The question boils down to how much, and if this is cash from the seller’s savings or partly a conventional loan.
Then come the financing terms. Everything from the timeline on the loan to the payment structures to the interest rate to continuation agreements need to be addressed.
The different scenarios are endless. You could use your basic structures, such as the straight amortization financing over ten years. Another option is to structure different payment amounts at various points, such as a larger payment after the first year and smaller payments the subsequent five years. We could also deploy a balloon payment model. Here we realize that most banks will loan to a business owner after they have been in business for two to three years. In this case, you write an interest-only loan to balloon in three years once the buyer qualifies for conventional lending and feels more confident about their investment.
Determining financing structure isn’t for the in-the-box type of crowd. In order to continue that tightrope walk, only creative thinkers need apply.
Creative Options to Get to the Finish Line
This is where my team and I earn our keep. Not only do we develop creative deal structures that balance risk, we also work to reduce your tax burden. That means more cash in your pocket, less money grabbing by good old Uncle Sam. When walking across the finish line, we want you to have more after-tax cash in your pocket.
And that’s only the beginning of our full-service firm offerings.
If you have an exit on the horizon, or are looking to increase the amount of cash you bring in an ongoing business sale, contact our team today. At Exit Consulting Group, we are uniquely qualified to serve business owners exiting their business. No matter where you are in the process, or how you plan to structure your transition, we will partner with you to help you realize your financial, personal and business goals.
Because your business exit deserves the best team at the helm, contact us at Exit Consulting Group today.