Business Brokers: Getting the Deal Financed
If you plan to work as a professional business broker, getting the deal financed will be a key issue in almost every transaction that you work on.
Lining up financing for the purchase of a small or mid-size business can be a bit dicey. There are always far more variables and concerns that lenders will raise than are encountered in the process of buying or selling a house.
Making sure that your client – the seller – is aware of these issues and the likelihood that something other than cash will be involved in the transaction is one of the most important aspects of a business broker’s job.
Let’s take a look at some of the issues.
Cash
Few buyers will want – or be able – to pay cash for the business they buy.
Astute buyers will want to take advantage of leverage whereby they can make the capital they are able to invest go much further than that capital on its own would be able to.
Like buying a house or other real estate, most buyers – at least those with adequate credit – will expect to be able to arrange some type of financing mechanism that will leverage their existing cash and allow them to buy a business that is much larger than their cash would otherwise permit.
What amount of leverage a buyer might enjoy will depend on the type and characteristics of the business, the deal structure and the buyer.
For example, an asset-heavy business, especially one that includes real estate, will be more attractive to conventional lenders and, thus, provide more leverage. Conventional lenders are well-experienced with real estate-based lending. It’s something they know. Other assets, such as inventory and FF&E, are less appealing to most conventional lenders and will generally involve a specialized lender, one that understands the business being sold.
A service business, on the other hand – one that is light on hard assets – will present more of a challenge in getting financed. Though clear, accurate financial information and strong recent growth will help in ALL financing efforts, these characteristics are even more meaningful to the financing when selling a service business.
There are two basic types of lenders: conventional and non-conventional.
Astute buyers will want to take advantage of leverage whereby they can make the capital they are able to invest go much further than that capital on its own would be able to.
Like buying a house or other real estate, most buyers – at least those with adequate credit – will expect to be able to arrange some type of financing mechanism that will leverage their existing cash and allow them to buy a business that is much larger than their cash would otherwise permit.
What amount of leverage a buyer might enjoy will depend on the type and characteristics of the business, the deal structure and the buyer.
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Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.
Become a Professional Business Broker…
Lenders
Conventional lenders include most commercial banks. The buyers of Main St and lower Middle Market businesses will likely look to their local banker to assist in the financing of the acquisition. Buyers will generally have a mortgage relationship with such bankers but local bankers are often quite skeptical about lending for the acquisition of a small business because, in their minds, small businesses represent a much higher risk than what they are comfortable with.
Such lenders will generally want the buyer to collateralize the loan with real estate but if the buyer doesn’t own any unencumbered real estate, most lenders will be hard-pressed to approve funding the deal.
Non-conventional lenders are willing to assume greater risk but that is in return for a higher interest rate. And in most cases, non-conventional lenders will require the borrower to put up real estate as collateral for the loan.
Middle Market Buyers
Buyers of Middle Market businesses fall into two basic categories: strategic acquirers and financial acquirers. Strategic acquirers are usually other businesses – often larger than the business being targeted for acquisition – that are looking for ways to leverage their existing business by adding a new and generally complimentary line of products or services to their existing offerings. Strategic buyers will often use a combination of cash and their own equity (stock) to purchase the target business. A business broker must be able to explain to his or her client the pros and cons of a cash and stock deal. Financial buyers – small private equity firms, family offices or high net-worth individuals – are generally interested in the cash the targeted business can generate and the growth potential of that business. Financial buyers will often use an “earn-out” to finance a portion of the purchase with the balance in cash.Seller Participation
One of the most important aspects of brokering businesses in the Main Street and lower Middle Markets is the realization and understanding that, in almost ALL cases, the transaction will involve some level of seller participation in the buyer’s financing.
In the Main Street market, more than 80% of deals we’re involved in include seller financing. It is impossible to overstate the importance of advising your selling clients about this statistic. If the broker’s valuation puts the business’ value at $880,000 and the recommended marketing price at $950,000, the seller will automatically assume that they will walk away from the closing table with a check for about $800,000 – and make plans for how to deploy that amount, whether that be buying another business or spending the next ten years racing yachts with The Big Dog. If the seller is unprepared for the likelihood that he or she will walk away with far less than that amount, their plans will be dramatically impacted and there is an excellent chance that the deal will collapse – and that the broker’s relationship will be in the tank.
Such a situation has the potential of causing untold reputational harm to the your business broker’s practice.
In the Main Street market, more than 80% of deals we’re involved in include seller financing. It is impossible to overstate the importance of advising your selling clients about this statistic. If the broker’s valuation puts the business’ value at $880,000 and the recommended marketing price at $950,000, the seller will automatically assume that they will walk away from the closing table with a check for about $800,000 – and make plans for how to deploy that amount, whether that be buying another business or spending the next ten years racing yachts with The Big Dog. If the seller is unprepared for the likelihood that he or she will walk away with far less than that amount, their plans will be dramatically impacted and there is an excellent chance that the deal will collapse – and that the broker’s relationship will be in the tank.
Such a situation has the potential of causing untold reputational harm to the your business broker’s practice.
The Bottom Line
One of the most important aspects of closing a deal is lining up the financing. And one of the most important jobs of the professional business broker is preparing the seller – our clients – so that they’re ready for the likely financing hurdles that nearly all legitimate offers will involve. This is part of the concept of managing the client’s expectations, a topic we cover at length in our course, The Basic “How-To” of Becoming a Business Broker™._____________________________________________________________________________
Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.
Become a Professional Business Broker…
Managing the client’s expectations begins with the first meeting and extends throughout your relationship with your client as that relationship evolves through the different phases of the selling process. If you do this properly – especially regarding how the acquisition of your client’s business will likely be financed – you’ll greatly reduce the chances of a deal going south at the last minute. If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast. I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week! Joe
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The author is the founder 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