Copyright 2011 by Toby Tatum, MBA, CBA
Nowhere is seller financing, also called seller carry-back financing, more prevalent than in the sale of small and lower middle market businesses. To begin this presentation, let’s look at the distribution of the percentage of the purchase price buyers pay in a down payment. Figure 1 presents this data from the 2010 edition of the Bizcomps database. The 2010 edition of Bizcomps includes data for the years 1995 through 2009.
Figure 1 (Based on 11,794 transactions)
From Figure 1 we see that in 39.2% of the transactions, the seller received all cash at closing. In a very significant percentage of these transactions however, the buyers obtained third-party financing, primarily via SBA 7a loans. Although it is impossible to know exactly what percentage of the all-cash-at-closing transactions were partially financed by a third-party lender, the point of this first presentation is to show that in 60.8% of all transactions, the seller partially financed the purchase price.
The other two elements of seller financing is the distribution of the interest rates these notes carry and the amortization periods. Figure 2 shows the distribution of interest rates and Figure 3 shows the distribution of amortization periods.
From the Figure 1 we see that approximately 60% of small and midsize business sales transact on terms wherein the seller partially finances the purchase by accepting part of the price in cash and part in a “seller carry-back” promissory note. The introduction of seller financing into price negotiations has enormous implications for a businesses’ most probable selling price. This is because a seller can get more for his business if he offers seller carry-back financing. To prove this point, Figure 4 illustrates the difference in the frequency distribution of the ratios of selling price divided by seller’s discretionary earnings (SP/SDE) for transactions partially finance by the seller compared to all-cash-at-closing transactions.
From Figure 4, it is clearly evident that there is a significant difference in these two frequency distributions, which is to say there tends to be a significant difference in the prices paid for businesses partially financed by the seller. On average, the selling prices for all-cash-at-closing transactions are 17.57% less than the selling prices for businesses partially financed by the seller. However, the average difference notwithstanding, in actuality, the more generous the financing terms from the buyer’s perspective in terms of a cash down payment, the interest rate on the note and the amortization period, the higher the price the seller can get. As the saying goes in the business brokerage business, “the seller names the price and the buyer names the terms; that’s how deals are made.”
Seller carry-back financing is attractive to buyers for several reasons:
Seller carry-back financing is also attractive to sellers for a number of reasons:
The truly amazing thing about seller financing is that in theory, any top-line selling price can be rendered reasonable from the buyer’s perspective for any business that provides at least enough cash flow to provide the buyer with a fair market value wage, by adjusting the terms of the seller carry-back promissory note. Obviously, if the asking price for a business is ridiculously higher than the most probable all-cash selling price, the seller financing terms that will make this price acceptable to a buyer will also be equally ridiculous—but with absolute certainty, seller financing terms can be developed that will render any asking price reasonable in theory from the buyer’s perspective. For a detailed explanation of this proposition together with demonstrations of how to calculate the necessary financing terms, go to www.TobyTatum.net