Finance a New Business

Finance a New BusinessThe epidemic of corporate downsizing in the US has made owning a business a more attractive proposition than ever before. As increasing numbers of prospective buyers embark on the process of becoming independent business owners, many of them voice a common concern: how do I finance a new business?

Prospective buyers are aware that the credit crunch prevents the traditional lending institution from being the likely solution to their needs. Where then can buyers turn for help to finance a new business, which is likely to be the largest single investment of their lives? There are a variety of financing sources, and buyers will find one that fills their particular requirements. (Small businesses–those priced under $100,000-$150,000–will usually depend on seller financing as the chief source.) For many businesses, here are the best routes to follow:

 

Buyer’s Personal Equity

In most business acquisition situations, this is the place to begin. Typically, anywhere from 20-50% of cash needed to purchase a business comes from the buyer and his or her family. Buyers should decide how much capital they are able to risk, and the actual amount will vary, of course, depending on the specific business and the terms of the sale. But, on average, a buyer should be prepared to come up with something between $50,000-$150,000 for the purchase of a small business.

The dream of buying a business by means of a highly-leveraged transaction (one requiring minimum cash) must remain a dream and not a reality from most buyers. The exceptions are those buyers who have special talents or skills sought after by investors, those whose business will directly benefit jobs that are of local public interest, or those whose businesses are expected to make unusually large profits.

One of the major reasons personal equity financing is a good starting point is that buyers who invest their own capital to start the ball rolling–they are positively influencing other possible investors or lenders to participate.

 

Seller Financing

One of the simplest–and best–ways to finance a new business is to work hand-in-hand with the seller. The seller’s willingness to participate will be influenced by his or her own requirements: tax considerations as well as cash needs.

In some instances, sellers are virtually forced to finance the sale of their own business in order to keep the deal from falling through. Many sellers, however, actively prefer to do the financing themselves. Doing so not only can increase the chances for a successful sale, but can also be helpful in obtaining the best possible price.

The terms offered by sellers are usually more flexible and more agreeable to the buyer than those offered from a third-party lender. Sellers will typically finance 50-60% or more of the selling price, with an interest rate below current bank rates and with a far longer amortization.  The terms will usually have scheduled payments similar to conventional loans.

As with buyer-equity financing, seller financing can make the business more attractive and viable to other lenders. In fact, sometimes outside lenders will usually have scheduled payments similar to conventional loans. Furthermore, sometimes outside lenders will refuse to participate unless a large chunk of seller financing is already in place.

 

Venture Capital

Venture capitalists have become more eager players in the financing of large independent businesses. Previously known for going after the high-risk, high-profile band-new business, they are becoming increasingly interested in established, existing entities.

This is not to say that outside equity investors are lining up outside the buyer’s door, especially if the buyer in counting on a single investor to take on this kind of risk. Professional venture capitalists will be less daunted by risk; however, they will likely want majority control and will expect to make at least 30% annual rate of return on their investment to finance a new business.

 

Small Business Administration

Thanks to the US Small Business Administration Loan Guarantee Program, favorable financing terms are available to business buyers. Similar to the terms of typical seller financing, SBA loans have long amortization periods (ten years), and up to 70% financing (more than usually available with the seller-financed sale).

SBA loans are not, however, a given. The buyer seeking the loan to finance a new business must prove stability of the business and must also be prepared to offer collateral–machinery, equipment, or real-estate. In addition, there must be evidence of a healthy cash flow in order to unsure that loan payments can be made. In cases where there is adequate cash flow but insufficient collateral, the buyer may have to offer personal collateral, such as his or her house or other property.

Over the years, the SBA has become more in tune with small business financing. It now has a program for loans under $150,000 that requires only a minimum or paperwork and information. Another optimistic financing sign: more banks and lending institutions are now being approves as SBA lenders to finance a new business.

 

Lending Institutions

Banks and other lending agencies provide “unsecured” loans to commensurate with the cash available for servicing the debt. (“Unsecured” is a misnomer, because banks and other lenders of this type will aim to secure their loans of the collateral exists.) Those seeking bank loans to finance a new business will have more success if they have a large net worth liquid assets, or a reliable source of income. Unsecured loans are also easier to come by if the buyer is already a favored customer or one qualifying for the SBA loan program.

When a bank participates in financing a business sale, it will typically finance 50-75% of the real estate value, 75-90% of the new equipment value, or 50% of inventory. The only intangible assets attractive to banks are accounts receivable  which they will finance from 80-90%.

Although he terms may sounds attractive, most business buyers are unwise to look toward conventional lending institutions to finance their new business. By some estimates, the rate of rejection by banks for business acquisition loans can go higher than 80%.

 

With any of the acquisition financing options, buyers must be open to creative solutions, and they must be willing to take some risks. Whether the route finally chosen is personal, through the seller, or third-party financing, the well informed buyer can feel confident that there is a solution to that big acquisition question. Financing, in some form, does exist out there.

Buying or Selling a Business: Why Do Deals Fall Apart?

arguing businessmen selling a businessBuying or Selling a Business: Why Do Deals Fall Apart?

 

In many cases, the buyer and seller reach a tentative agreement when selling a business, only to have it all fall apart. There are some reasons this happens, and once they are understood, many of the worst deal-breakers can be avoided. Understanding is the key word. Both the buyer and seller must develop an awareness of what the sale involves–and such an awareness should include facing potential problems before they swell into the flood-waters and “sink” the sale.

Now, what keeps a sale from closing successfully? Surveyed business brokers across the United States found similar reasons that were cited so often that a pattern of causality began to emerge. A compilation of situations and factors of which affect the sale of a business are explained below.

 

The Seller Fails to Reveal Problems

If and when a seller is not up-front about any of the problems with the business, that does not mean these problems will go away when the buyer takes over. The problems are bound to show up later, usually sometimes after a tentative agreement has been reached. The buyer then gets cold feet–hardly anyone in this situation likes surprises–and the deal promptly falls apart. Event though this may seem a tall order, sellers must be as open about the negatives of their business as they are about positives. Again and again, business brokers surveyed said: “We can handle most problems…if we know about them at the start of the selling”.

 

The Buyer Has Second Thoughts About the Price

In some cases, the buyer agrees on a price, only to discover that the business will not support that price, in his or her opinion. Whether this “discovery” is based on gut reaction or a second look at the figures, it impacts seriously on the transaction at hand. The deal is in serious jeopardy when the seller wants more than the buyer feels the business is worth. It is of paramount importance that the business be fairly priced when selling a business. Once that price has been established, the documentation must support the seller’s claims so that buyers can see the “real” facts form themselves.

 

 Both the Buyer and the Seller Grow Impatient

During the process of buying or selling a business, it’s easy for either party to let impatience settle in. Buyers continue to want increasing varieties and volumes of information, and sellers grow weary of it all. Both sides need to understand that the closing process of selling a business takes time. However, it shouldn’t take so long that the deal becomes endangered. It is important that both parties should use only those knowledgeable in the business closing process if they are using outside professionals. A business broker is one of the most competent outside professionals in a given business area, and these should be given strong consideration in putting together the “team”. Seller and buyer may be inclined to use an attorney or accountant with whom they are familiar with, but these people may not have the experience to bring the sale to a successful conclusion.

 

The Buyer and the Seller are Not (Never Were) in Agreement

How does this situation arise? Unfortunately, there are business sale transactions wherein the buyer and the seller realize too late that they have not been in agreement all along–they just thought they were. Cases of miscommunication are often fatal to a successful closing. A professional business broker is skilled in making sure that both sides know exactly what the deal entails, and can reduce the chance that such misunderstandings will occur.

 

The Seller Doesn’t Really Want to Sell

In all too many instances, the seller does not really want to be selling the business. The idea had sounded so good at the start, but now that things have come down to the wire, the fire to sell has all but diminished. Therefore, it is key that prospective sellers make a firm decision to sell a business prior to going into the market with the business. If there are doubts, these ought to be quelled or resolved. Some sellers enter the marketplace just to test the waters; they want to see if they could get their “price” if they ever get really serious. This type of seller is the bane of business brokers and buyers alike. However, business brokers generally can tell when they encounter the casual (as opposed to the serious) seller. But an inexperienced buyer may not recognize the difference until it’s too late. Most business brokers will agree that a willing seller, is a good seller.

 

Or the Reverse: The Buyer Doesn’t Really Want to Sell

What’s true for the mixed-emotion seller can be flipped around and applied to the buyer as well. Full of excitement and optimism, buyers can enter the sale process but then begin to drag their feet as they draw nearer to the “altar”. This is especially true today with so many displaced corporate executives entering the market. Buying and owning a business is still the American dream–and for many it becomes a profitable reality. However, the entrepreneurial reality also includes risk, a lot of hard work, and long intense hours. Sometimes this is too much reality for a prospective buyer to handle.

 

None of the Above

The situations detailed above are the just the main reasons why deals fall apart. However, there can be problems beyond anyone’s control, such as Acts of God, unforeseen environmental problems, etc. But the good news is that many potential deal-crushers can be handled or dealt with prior to the marketing of the business, to help ensure that the sale will close successfully.

 

A Final Note

Remember these four components in working toward the success of the business sale:

  • Good chemistry between the parties involved
  • A mutual understanding of the agreement
  • A mutual understanding of the emotions of both buyer and seller
  • The belief, on the part of both buyer and seller, that they are involved in a good deal

Should I Hire a Business Lawyer?

Sellers and Buyers should have a business lawyer for preparation and review of the legal documents.  Make sure that the attorney you hire has time in his or her schedule to devote to your transaction and have relevant experience in advising buyers regarding business transfer transactions.  Lack of experience often translates into the buyer paying for education of the attorney.  Most business brokers have lists of attorneys who are familiar with the business buying process.  An experienced attorney can be of real assistance in making sure that all of the details are handled properly.  Business brokers are not qualified to give legal advice.

However, keep in mind that many attorneys are not qualified to give business advice. Your attorney will be, and should be, looking after your interests; however, you need to remember that the seller’s interests must also be considered. If the attorney goes too far in trying to protect your interests, the seller’s attorney will instruct his or her client not to proceed. The transaction must be fair for all parties. The attorney works for you, and you must have a say in how everything is done.

If you know someone who has owned their own business for a period of time, he or she may also be a valuable resource in answering your questions about how small business really works.

You have to make the final decision; that “leap of faith” between looking and actually being in business for yourself is a decision that only you can make!

Why should I go to a business broker?

A professional business broker can be helpful in many ways. They can provide you with a selection of different and, in many cases, unique businesses, including many that you would not be able to find on your own. Approximately 90 percent of those who buy businesses end up with something completely different from the business that they first inquired about. Business brokers can offer you a wide variety of businesses to look at and consider.

Business brokers are also an excellent source of information about small business and the business buying process. They are familiar with the market and can advise you about trends, pricing and what is happening locally. Your business broker will handle all of the details of the business sale and will do everything possible to guide you in the right direction, including, if necessary, consulting other professionals who may be able to assist you.

Your local professional business broker is the best person to talk to about your business needs and requirements.

What happens when I find a business I want to buy?

When you find a business, the business broker will be able to answer many of your questions immediately or will research them for you. Once you get your preliminary questions answered, the typical next step is for the broker to prepare an offer based on the price and terms you feel are appropriate. This offer will generally be subject to your approval of the actual books and records supporting the figures that have been supplied to you. The main purpose of the offer is to see if the seller is willing to accept the price and terms you offered.

There isn’t much point in continuing if you and the seller can’t get together on price and terms. The offer is then presented to the seller who can approve it, reject it, or counter it with his or her own offer. You, obviously, have the decision of accepting the counter proposal from the seller or rejecting it and going on to consider other businesses.

If you and the seller agree on the price and terms, the next step is for you to do your “due diligence.” The burden is on you – the buyer – no one else. You may choose to bring in other outside advisors or to do it on your own – the choice is yours. Once you have checked and approved those areas of concern, the closing documents can be prepared, and your purchase of the business can be successfully closed. You will now join many others who, like you, have chosen to become self-employed!

What does it take to be successful?

Certainly, you need adequate capital to buy the business and to make the improvements you want, along with maintaining some reserves in case things start off slowly. You need to be willing to work hard and, in many cases, to put in long hours. Unfortunately, many of today’s buyers are not willing to do what it takes to be successful in owning a business. A business owner has to, as they say, be the janitor, errand boy, employee, bookkeeper and “chief bottle washer!” Too many people think they can buy a business and then just sit behind a desk and work on their business plans. Owners of small businesses must be “doers.”

What should I Look for?

Obviously, you want to consider only those businesses that you would feel comfortable owning and operating. “Pride of Ownership” is an important ingredient for success. You also want to consider only those businesses that you can afford with the cash you have available. In addition, the business you buy must be able to supply you with enough income – after making payments on it – to pay your bills. However, you should look at a business with an eye toward what you can do with it – how you can improve it and make it more productive and profitable. There is an old adage advising that you shouldn’t buy a business unless you feel you can do better than the present owner. Everyone has seen examples of a business that needs improvement in order to thrive, and a new owner comes in and does just that. Conversely, there are also cases where a new owner takes over a very successful business and not soon after, it either closes or is sold. It all depends on you!

How are businesses priced?

Generally, at the outset, a prospective seller will ask the business broker what he or she thinks the business will sell for. The business broker usually explains that a review of the financial information will be necessary before a price, or a range of prices, can be suggested for the business.

Most sellers have some idea about what they feel their business should sell for – and this is certainly taken into consideration. However, the business broker is familiar with market considerations and, by reviewing the financial records of the business, can make a recommendation of what he or she feels the market will dictate. A range is normally set with a low and high price. The more cash demanded by the seller, the lower the selling price; the smaller the cash requirements of the seller, the higher the price.

Since most business sales are seller-financed, the down payment and terms of the sale are very important. In many cases, how the sale of the business is structured is more important than the actual selling price of the business. Too many buyers make the mistake of being overly-concerned about the full price when the terms of the sale can make the difference between success and failure.

An oft-quoted anecdote may better illustrate this point: If you could buy a business that would provide you with more net profit than you thought possible even after subtracting the debt service to the seller, and you could purchase this business with a very small down payment, would you really care what the full price of the business was?

What is the real reason people go into business for themselves?

There have been many surveys taken in an attempt to answer this question. Most surveys reveal the same responses, in almost the same identical order of priority. Here are the results of a typical survey, listed in order of importance:

1. To do my own thing, control my own destiny.
2. Don’t want to work for someone else.
3. To better utilize my skills and abilities.
4. To make money.
*It is interesting to note that money is not at the top of the list, but comes in fourth. 

Why should I buy a business rather than start one?

An existing business has a track record. The failure rate in small business is largely in the start-up phase. The existing business has demonstrated that there is a need for that product or service in a particular locale. Financial records are available along with other information on the business. Most sellers will stay and train a new owner and most will also supply financing. Finding someone who will teach you the intricacies of running a business and who is also willing to finance the sale can make all the difference.

DISCLAIMER: TM Business Brokers, LLC does not offer securities for sale, real estate brokerage services, accounting, tax or legal advice, or financing negotiations. TM Business Brokers, LLC does not audit / verify any information provided by business owners and their third party advisers, and we make no representations or warranties thereto.