Buying a Business With No Money Down
18 September 2023: Buying a Business With No Money Down
An interesting coincidence occurred to us recently.
On two occasions in the past 10 days, the topic of buying a business with no money down came up – once in an email exchange with someone interested in doing just that and then in a video call with a consultant who is considering joining a group of small investors to acquire small family businesses in a specific industry; a “roll-up“, if you will.
I refer to these two events as a “coincidence” because getting even one such inquiry in a decade is odd. Getting two in 10 days is singularly uncommon.
This Thursday, 21 Sept., at 3 PM EDT on The Brokers Roundtable℠, we are conducting a Live Stream interview and Q&A on the topic of financing the acquisition of a business with Small Business Administration expert, Dave Moore of Acclivity Financial, a Preferred SBA lender. If you are a member of The Brokers Roundtable℠, simply go to Community Events and click on the event title to join.
To be clear, the first inquiry may have come from someone with experience buying small residential properties, a market that, in certain areas and under certain conditions, may lend itself to no-money-down deals. But the real estate selling market is completely different from the business selling market.
This fellow – who claimed to be interested in buying a business – used the argument that a business owner would seemingly jump at the opportunity to finance the purchase of their business because by doing so, they would significantly reduce the capital gains tax liability.
The second inquiry was from someone who claimed experience in upper levels of business management and was really about methods of financing the acquisition of small so-called “mom and pop” and lower Middle Market businesses. This consultant was considering joining a roll-up in an industry that has been pretty hot lately and his question suggested that he, or the group he represented, had an appetite for these businesses that may have been greater than the amount of capital available to get the deals done.
But let’s first address the question directly. Is buying a business with no money down even possible?
Well, yes. But it’s highly unlikely.
Let’s look at the capital gains tax argument first.
What is a Capital Gain?”
When considering capital gains, the most important thing to understand is the word “gains”. As you might assume, that word refers to the economic “gain” in the value of the business during the owner’s period of ownership; a gain that is not realized until the business is sold. It is NOT the selling price of the business.
To explain this in the simplest of terms, we’ll use a basic real estate example.
If you buy an investment property for $200,000 and sell it five years later for $400,000, you have a “gain in value” of $200,000 (all other considerations aside). That’s your capital gain and that’s what gets taxed. The first $200,000 of the sale price is simply getting your investment back. There’s no tax on that (at least not yet).
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
The same concept is applied in the sale of a business. The return of the owner’s original investment capital is not taxed when that business is eventually sold.
For example, let’s imagine a couple starts a tractor-trailer leasing company. They invest $2 million in 50 trailers, one or two tractors (to move the trailers around), a thorough marketing effort and software for tracking everything that’s out on the road. If they sell the business in 10 years for $5 million, the simple math suggests they’d be taxed on the $3 million gain, right?
Well, yes. But it’s not that easy.
Consider that over the next 10 years, they invested some of the annual profits back into the business. They now have 150 trailers, expanded office space, more robust software, etc. After 10 years, the business is worth $12 million but over that period of time they’ve invested a total of $6 million – their original $2 million plus $4 million from the business’ profit for all that cool new stuff. Their “gain” in value is then $6 million – and that’s what gets taxed.
So, if the first $6 million of the $12 million sale is not taxed, the capital gains tax argument is without merit. Even if the sellers, in an effort to defer the taxes on the $6 million gain, agreed to finance the entire gain, the buyer would still need to come up with $6 million.
Financing Methods and Risk
As to the consultant thinking about a roll-up, if the targeted businesses are profitable, a buyer must ask themselves, what is the owner’s motivation?
Consider that a profitable business that is priced correctly is likely to find multiple potential buyers. A “no-money-down” (“NMD”) buyer is competing with those other buyers. What can the NMD buyer offer to motivate the seller to finance the entire deal? A higher price? Possibly, but that changes the economics of the deal, usually considerably. And everyone involved is surely aware of the seller’ significantly greater risk which alone would command a higher price thus changing the economics of the deal even more.
And speaking of risk, for a seller, a no-money-down deal is the riskiest of their career. The buyer, with no skin in the game, could simply milk the business for 90-120 days – stall in paying suppliers, withhold the rent, stiff the electric company, not submit payroll taxes, bilk the employees with bad final checks – putting everything that comes in into his own pockets and relocate his now fabulously wealthy backside to that little beachfront getaway in the Azores he’s been funding surreptitiously.
The seller gets nothing, feels compelled to make the last payroll’s bad checks good, and embarks on a grueling, year’s-long, spirit-shattering battle with the tax authorities that will surely, along with what had been a planned peaceful retirement, be lost.
To even think about a no-money-down deal, you’ve got to consider the seller’s motivation. What could it be?
Sometime around 1980, a man named Mark Haroldson published a book about buying real estate with no money down. The premise of the book – which focused on residential property – was that there are owners of houses and small apartment buildings – “mom and pop” investors – that are in a “must sell” situation and would be willing to finance 100% of the purchase price just to get out. Bad tenants, crushing debt, divorce, etc., all drove such decisions.
In his book, Haroldson referred to such owners as “don’t-wanters”. And he explained that “don’t-wanters” are motivated by the fact that they’ve got to stop the bleeding; that is, the cost of ownership. After all, it doesn’t matter whether any rent is coming in; expenses – interest, taxes, maintenance, etc. – are still going out. If a house is empty or the tenant isn’t paying, the mortgage payment is still due every month.
When it comes to a business, this motivation is somewhat different. To “stop the bleeding” most business owners simply have to close the doors and sell off any assets.
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Now, after all that, is a 100% seller-financed deal still possible?
Yes, but consider this: if the business is listed by a business broker, how does the broker get paid?
Does the buyer expect the broker to finance the commission? I’ve seen this just once in more than 20 years brokering businesses and that instance required a personal guarantee of payment from the seller (whether he got paid or not), a seller with a fairly strong financial statement (to back up that guarantee) and a broker with a strong book-of-business. It also required a long-standing friendship between the seller and the broker.
We’ve seen near-100% financing deals done. In fact, not long after I first got started back in 2001, I was involved as the broker in two. Both were very small businesses – one a restaurant, the other a delicatessen – that were sold for less than $100,000. The owners were what Mark Haroldson described as “don’t-wanters”. But one of those deals required the seller to come out of pocket for the commission so it was the ONLY no-money-down deal I’ve ever seen. The other required the buyer to come up with an amount to at least cover the commission.
At the time, I was like most brokers just starting out: certainly NOT “a broker with a strong book-of-business”.
The Bottom Line
If a buyer would stop for a moment and ask the question, “what would be the seller’s motivation for agreeing to a 100% seller-financed deal?”, it will usually become apparent pretty quickly that there really isn’t any. There are many buyers, 99% of whom have capital to make the purchase.
The most likely place to find Haroldson’s “don’t-wanters” is in the tiny market but even there most buyers have some capital.
Yes, somewhere in the area of 80% of deals in the Main Street market involve some aspect of seller financing but aside from the one way back when I first started, we’ve never seen one in which no buyer capital is part of the deal.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
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I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com