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Types of Financing for Buying a Business

Overview

There are many ways to pay for the purchase price during the sale of a business – all cash, traditional financing with a bank, seller financing with a promissory note, or some combination of the above. When discussing the payment options with the other party you should keep in mind that you are not limited to only 1 option. You can be creative in how, when, and what form payments are made. Below are some of the main ways to finance a business purchase.

Cash Payment

If a buyer can pay the full purchase price, cash is king. While this is rare, it does occur.

SBA Loan

A loan from the Small Business Administration (“SBA”) or a bank is the most traditional way to finance a business purchase. The terms are standardized, the seller and buyer both know what they are getting, and there is little to negotiate over. The pros are the seller tends to get fully paid out and the buyer has a neutral 3rd party to make payments to. The cons are that these loans often do not provide for tailoring or flexibility even if there are multiple options to choose from. On the other hand, these loans tend to have lower rates and longer repayment periods than other loans. The SBA will have many insurance requirements to meet in order to guarantee loans to small-business owners, however, getting the right type of collateral to keep as security, such as key man disability insurance, could help you streamline the entire process.

Promissory Note

A promissory note is basically a loan from the seller to the buyer to purchase the business. The benefit of a promissory note is that the payment terms can be as flexible as the parties want, which allows for a lot of creative financing.

The most traditional is a guaranteed payment, such as monthly installments. The pros of this are that the seller and buyer know what to expect each month. The cons are that businesses don’t always have consistent revenues, and this can be hard on a new business owner, especially right after the transition.

Other forms of payment include revenue-based payments where the installment is a percentage of the company’s revenue or another financial base. This option allows for expected payments but in unknown amounts. Each month the buyer must determine the amount of the installment. The pros of this are that the seller still receives a timed installment and the buyer has the flexible payment amount to adjust for seasonal changes in the business.

An even more complex payment method would be an earn-out. Earn-out provisions are where either all or part of the purchase price is based on the future performance of the business. The pros of an earn-out provision are that it incentivizes a seller who is providing post-closing services to see the business perform well because it increases the purchase price, and it protects the buyer from paying a purchase price that may not reflect the performance of the business. The cons are that earn-out provisions have a high risk of dispute because the earn-out metrics require a lot of monitoring and disclosures.

Combination Financing

Sometimes the best route is a combination of one or more of the above financing options. For some deals, a cash down payment may be followed by a conventional bank loan and the remainder made up with a promissory note. Alternatively, you could also consider obtaining a commercial bridge loan for the period of time you expect you might take to optimize your business. Therefore, you have different options to find a creative way to pay the purchase price.

Ultimately, the parties should find financing that best balances their needs. The best way to minimize the risk that a purchase price is not fully paid is to find the options that work with both parties’ needs. To do this, it is best to work with your financial team and an attorney to make sure the transaction’s documents reflect what is agreed upon.

The above article is for general information purposes only and should not be relied upon as specific legal advice. This article, or contacting Apex, does not in any way form an attorney-client relationship. If you have any questions or would like to learn more, please contact Tara Vitale at tara@apexlg.com.

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