When a small business owner intends to sell their business, and when someone is considering purchasing a small business, there are some business financing basics that both sides should consider.
And for the purposes of this discussion, when I speak of small business, I’m talking about a business entity with no greater than $2,000,000 in annual sales.
When it comes to business financing, the most important aspect of any small business purchase is historical cash flow that is supported by third party financial statements and seller provided source documents if required.
The harder the cash flow is to figure out or verify, the harder its going to be to get both sides to agree on a sale price.
The second element of financing a small business purchase is the composition of the assets being purchased and offered as security to a third party lender.
When the sales price is allocated into tangible and intangible assets, third party lenders are going to be very interested in the amount of goodwill that is included in the deal.
Goodwill represents the value placed by the seller on the future revenues of the business which represents potential revenues not yet earned.
Its not uncommon for a third party source of business financing to only finance a portion of goodwill or none at all.
The expectation of the lender is that either the buyer will be paying cash for the goodwill or the seller will finance it over time.
The biggest risk to the lender when considering a business acquisition financing request is the change of control risk.
The transition period where ownership and control shifts from the buyer to the seller will always be key to longer term business success.
To help manage this risk, business lending sources will look to a financing structure where the risk of potential loss is shared fairly among the buyer, seller, and lender.
Many small business purchases are financed on this basis with each party contributing or being responsible for financing one third of the final purchase price.
Especially when there is a significant amount of goodwill involved, the lender may only be interested if the vendor is also providing financing.
This is also why its very uncommon to see a small business purchase being financed largely by just a third party lender.
When you have a buying or selling situation where all parties involved understand and are prepared to help guarding against short term business failure, then its more likely that third party business financing can be arranged to complete the transaction.