Seller Carryback
Financing the sale of your business can be a gamble. Most business owners reach a point when they are ready to retire or explore new challenges, but find that much of their net worth is tied up in their existing business.
Selling the business might be the obvious answer, but at what cost? Owner financing is a common alternative to a traditional cash sale and the buyer’s need to obtain financing. Rather than accepting only cash, the seller allows the buyer to pay some or all of the purchase price in the form of a promissory note to the owner. But is it a good idea? The owner may believe that he or she is selling the existing business; but in truth they are actually investing in the business’s future operated with new management and ownership.
We all know that small businesses can be risky. The failure rates for businesses can be high whether a new entity, an existing business under new ownership, or a franchise. Depending on the industry sector, location, proficiency of management and prevailing economic conditions, failure rates can be significant. According to the Bureau of Labor and Statistics, less than fifty percent (50%) of startup businesses survive through year five and only about a third of businesses make it ten years. If you are expecting the promissory note on your former business to finance your golden years, you might be setting yourself up for an unpleasant surprise.
Some questions to consider in deciding whether to personally finance the sale of your business:
Would you be willing or able to retake control of the business in the event of default? Could you regain customers lost because of mismanagement by the new owner?
Why are you considering owner financing? Is the valuation of your business preventing a third-party lender from making the loan to the buyer? Would it be worth accepting a lower valuation to have all the cash in your pocket now and know that you could walk away?
Can the business support the payments on the owner financed note? If you cleared $3,000 a month while running the company, you cannot expect the new owner to service a note with payments of $5,000 a month, particularly while he or she is still getting familiar with running the business.
It is not enough for a new owner to be creditworthy; he or she needs to be “business-worthy.” He or she needs to have the knowledge and business experience to successfully run your company after you sell. If the business fails, you will be saddled with an unpleasant decision: Come out of retirement to save the business or let your investment die. Unfortunately, I have seen this scenario play out many times in my practice. For a few clients who were not actually ready to retire, the comeback has been a joy. But for the vast majority, an owner-financed note in default has been an expensive and aggravating ordeal.
Don’t gamble more than you are prepared to lose. That’s good advice in Las Vegas, but it also holds true in the world of owner financing, where the odds might be even worse.