Make a Clean Break When <a href="http://www.VotanWeb.com" style="text-decoration:none;color:black">Buying a Website</a>
By PAULETTE THOMAS
Question: I'd like to find business owners who are interested in selling their business in the next two to five years. I'd pay them rent, and a portion would go to escrow towards buying the business when they decide to leave. Does this sound like a reasonable offer to make?
-- Lyle, New Brunswick, N.J.
Lyle: Sort of like the layaway plan that department stores used to offer buyers of pricey suits or bed linens? Except in this case, you'd buy the whole store.
We'll give you an "A" for an imaginative approach. "If someone doesn't have a lot of cash, this is certainly a creative way to work out financing," says Nick Nicholson, an Atlanta business broker, who helps business owners sell their enterprises.
What you propose is another flavor of seller financing, which is quite typical in sales of small businesses. By some accounts, about three-quarters of small businesses change hands with seller financing, meaning the seller loans you the money to buy his business. A hefty down payment is also typical, routinely 30% to 50%, say business brokers.
But according to Mr. Nicholson and other experts, it's likely to be difficult for your particular proposal to make the grade in the real world. "From my perspective, this is not a good way to sell a business," he says. In a more typical seller-financed transaction, the owner sells you the business under the terms spelled out in the lending agreement, say at the prime rate, plus two percentage points. Then the seller exits, and you run your business and pay back his loan to you.
Your plan has you working side by side with the seller for several years, and that raises questions. Mr. Nicholson believes that when a buyer comes in to take over a business, it's in everyone's interest to move out the seller sooner rather than later. Remember, there's a strong psychological bond between an entrepreneur and his creation. To many sellers, selling the enterprise is akin to letting go of one's child. Do you want to be making plans to improve margins or fire a lazy employee while he or she is defending the status quo?
"What he is asking for is a long-term relationship," says Mr. Nicholson. "Those usually don't work out." And in his experience, the No. 1 reason why a transaction falls through: The seller changes his mind. A slow-motion sale gives the seller ample opportunity to do that.
Another skeptic of the idea is Jack Roseman, director of Pittsburgh's Roseman Institute, which coaches and mentors chief executives of growing enterprises. In his view, the seller could probably sell the business for four to six times cash flow anyway, so why would he wait around and work with you as you pay him through cash flow? "I see the biggest issue here being that the risk is only on the seller," Dr. Roseman says. "I think it's a tough sell."
He imagines special circumstances where a business owner might sell under the terms you envision, but I don't know that these apply to you. "You might have an owner who doesn't want to close the business, so he works out a sale with someone who is a loyal employee," says Dr. Roseman. He adds, "These are cases where it's not sold purely on a financial basis."
Sometimes, to aid an attractive buyer, a seller might offer, say, an interest-only loan for a year or two, and then begin principal payments in the later years. Terms are often five years or so, says Mr. Nicholson. This gives the buyer some breathing room in his early years of owning the business, when cash may be particularly tight.
Of course, some would say, why not go to a bank? Truthfully, it's tough to qualify for bank financing to buy a business unless you have a sterling record. Lenders talk generally about the "five C's" of credit. They are:
conditions of the business and economy,
character,
capacity to repay,
collateral and
capital.
"You'd be surprised how difficult it can be to get a loan," says Mr. Nicholson. If you fall short on any one, you're better off pursuing other courses.
A last bit of counsel from Mr. Nicholson, though most entrepreneurs loathe hearing it: "I advise buyers to hold a job for a while to save some money. You don't want to come in underfinanced.