Buying a Business - Financing the Purchase - The Rules Have Changed

Everyone is consumed with the current economy and it is clearly impacting the sector of buying a business. Today, I want to talk about the impact of financing a business purchase. Whenever I touch upon this subject and specifically seller financing, I always get an unusually high number of comments from the business broker community (mostly from the west coast interestingly enough), so I am certain today will be no different.

In preparation for today’s post, I have spoken with over sixty business brokers, lenders, and loan brokers across the country in the past month. To those who were kind enough to share their thoughts with me, I want to thank you again for your honest feedback. In measuring their business activity, they report that business sales, in the pure main street business brokerage field, is down anywhere from twenty to fifty percent thus far in 2008.

It’s not at all surprising.

There are two main contributing factors to the decline. First, the tightening of the credit markets is an obvious culprit. According to a June 20, 2008 BusinessWeek article written by Jeremy Quittner, in the first quarter report from the SBA, loans for their 7(a) program were down eighteen percent. I would imagine that the second quarter is at least as bad. The article also mentions that over three hundred banks have opted out of the SBA program since 2006. While these statistics may be somewhat skewed because there has been a drastic decline in Express Loans, it is reported that overall volume of SBA 7(a) loans from the Bank of America (the 2007 leading SBA lender) was down forty percent in Q1 2007, and loans by Capital One (the third largest lender), dropped fifty-three percent.

Second, and more important I believe, is the fundamental lack of people’s confidence in the economy. Regardless of what happens to the stock market, interest rates, or unemployment figures, when confidence is lost, business buyers will tread with the utmost caution. Unless they are convinced that any decline is short-term, and the business can be sustained and grown, they will not be able to pull the trigger.

Resolution is going to take time. Confidence is not something that any business broker or owner can restore to the buyer market.

On the former point of financing, with the current credit markets, sellers will have to readjust their thinking. If buyers don’t have the assets to fund a purchase and if lenders are not lending, then sellers have to take up the slack. If not, the business for sale market will continue to trend downward.

I have long held the opinion that sellers need to assume part of the risk in a business sale. Further, as many businesses experience a recent decline, the only way they can validate what they have represented to the buyer, and demonstrate their confidence in the business, the industry, and the customers, is to participate in the financing of the deal.

There’s no choice. There are simply not many people walking around with ample liquid assets to buy a business. As their net worth’s have declined, mainly due to their real estate holdings, fewer of them will qualify for SBA. Most cannot tap in to their home equity to fund down payments or to secure any third party financing. When you add the fact that a declining business may not meet lender criteria either, then buyers and sellers are getting hit at both ends.

As I mentioned earlier, I am sure I’ll get slammed with some comments from brokers who are going to tell me that seller financing “does not happen here”. Let me save you the time and tell you that unless your region is thriving (and I don’t see more than a slim few that are), it’s time for seller financing to start happening in your backyard.

Having said this, I still believe that right now is a tremendous time to buy a business. While there are fewer qualified and serious buyers on the market, whenever there is upheaval in a sector, opportunities abound. I learned a long time ago that opportunity comes in a second and is gone in a flash. Actually, an opportunity is never lost; someone else will recognize and seize it. So for you buyers: don’t let a good business slip through your hands! Just prepare yourself properly and know how to leverage the deal.

There’s an article on our website that discusses all the current economic problems and the business for sale market that has generated an incredible number of views and I urge anyone thinking about buying a business to read it. Click here now to read about buying a business in today’s economy.

Have a good week. As always, I look forward to your comments.

Comments

[tim flanagan]

I am currently in the process of buying a business and the financing has been challenging to say the least. Even with excellent credit and considerable money to put down, the company has a lot of goodwill and we are having difficulty finding banks willing to finance. We have come full circle to the sellers to have them hold more of the note. Your story reinforces that position.

[ed]

The biggest problem in the purchase of a business is usually the seller's unrealistic view of the business in a declining economy. Cashflow from 2006 or 2007 or even 1st Q 2008 isn't cashflow in 3rd or 4th Q 2008 or 2009 and price needs to be adjusted accordingly or seller needs to assume some risk. The problem is often the brokers aren't particularly imaginative.

[Gary Lee]

As a small private equity investment group, we are less dependent on bank financing that most others searching for small businesses acquisitions. But I would like to add one aspect of buying that you have not touched on, and which all buyers must be aware of: the current credit conditions with banks has resulted in a sharp pull-back in working capital financing for existing small businesses. We recently looked at a company in Sacramento which has a solid defensible niche, EBITDA margin around 12%. The sales have been expanding even in the first 6 months of this year, but they are facing working capital issues as their banks have put a cap on working capital/factoring limits, especially on overseas sales. Now that is a double whammy because the overseas market is the key driver of growth currently, and without adequate working capital facilities, we as buyers actually need to invest more than just the sum paid to the seller. In this case, we estimated that the banks were cutting back the company's evergreen loan limit by 35%. We needed to invest an additional $1.2m, over and above the $3m paid to the seller. Naturally, we were not able to make the deal work, as neithre the seller was willing to take on more vendor financing, and the bank would not provide any guidance on when working capital limits would be restored. This additional working capital investment needs to be factored in by all sellers.

[Bret]

As a successful business broker of over 18 years I think your article is right on, except in my opinion, business sales are down more than 50%. I've never experienced a bad year until this year. Buyer interest and confidence is the worst I've ever experienced. Buyers are extremely cautious and hesitate to act. Sellers have not lowered their expectations yet and the owners with good businesses are holding on and are deciding not to sell now, but in a few years.

[Mark Bodzin]

Richard: I just read your very good comments about seller financing on BizQuest. I operate a small brokerage office in Dallas and have been brokering for 22 years. Two weeks ago, I transacted an auto aftermarket business that sold for $2M. My buyer has near perfect credit (800+) and the business has adjusted cash flow of $600K. Buyer was willing to put down $500k and looking for a $1.2M SBA loan with the seller carrying the balance. Long story short, Buyer could not secure an SBA loan after speaking with 3 different banks. We closed the deal with the Buyer putting his $500k down and the seller caring $1.5M, 10 years, 7%. Everyone is happy. This is a very solid business, a well qualified buyer, and seller had to end up carrying the deal. The banks in Dallas are scared to death. Sellers must consider carrying part of the purchase price or they probably will not be selling their business. Keep up the good work,