Questions on Seller Financing? ideal amount mergers and acquisitions business brokers smb

this week i've got a couple of questions about seller financing when buying a business hey there everyone it's david barnett from davidcbarnett.com the blog site and the show where i talk about buying selling and growing small and medium-sized businesses while managing risk so if you've been looking to level up in your life and discover your true calling and or you're already a business owner looking to expand or grow or to exit one day you've come to the right place because i share knowledge information and thought provoking opinions make sure that you sign up for my email list so that we can always stay in touch and you can find that directly over at davidcbarnettlist.com all right i've got some great questions so let me read the first one um a couple years ago i recorded a video called uh vtb questions from nyc and it was a student actually who had sent me a bunch of questions and i recorded a video and billy b asked a question he said if in seller financing if a buyer defaults on the loan is it likely that the seller will sue them to get the amount agreed to i think this is a great question because it of course the answer to the question is one that's going to frustrate everyone it depends because here's here's the scenario um there's two scenarios there is the scenario where you buy a business and then very quickly default right and so then the question is in the note what are the guarantees or collateral for the note my students are encouraged to make the business the collateral so if you defaulted on the note if you couldn't make the seller finance payments and then you surrendered the business back to the seller then then they've got the collateral back they got the business back so then the question would be did you also personally guarantee the note right and so and again i'll point out i'm not an attorney so you should have this kind of conversation with your attorney in discussing scenarios about the risks of buying a business but if there was a personal guarantee on that note then that would in my mind open the door to the seller wanting to sue you now let's talk reality if you took all of your savings and you put it into a business deal and you borrowed money from a bank or took over some leases and you also bought money from a seller and you somehow got into a position where you are not able to make payments my guess is you don't have a whole lot of money left over so very few people in their attorneys are anxious to spend money suing someone who's broke so you can stew on that but i you know so so basically i tell people you have to negotiate a personal guarantee um if you're putting everything into this deal and you really want this deal to work out then is there going to be anything left you know over so if you're a multi-millionaire and you're doing a deal for a couple hundred thousand dollars then it's going to be more concern to you than if you are putting like you know most of your money into a deal and in reality the failure doesn't happen right away it usually takes some amount of time so let's fast forward to that scenario so let's say you buy a business and you put money into it and you take on a bank loan and you also have a seller financing note then let's say the note is a five year note and you get four years into the deal and then things fall apart something happens the deal the business fails well that seller now has collected eighty percent of the payments and if there's interest on the note it means that they probably collected more than 80 of the original amount that you owed to them and so those sellers are going to have to think long and hard about whether it makes sense they're going to have to evaluate whether you have anything to go after and they're also going to have to evaluate whether it makes sense for them to engage with an attorney and pay a retainer fee in order to go after pursuing you because if you only owe them like 30 or 40 grand and the lawyer is going to want maybe 10 grand as a retainer then it very quickly you see that it doesn't make a lot of sense for someone to do that and so these are the practical considerations and if you if you want to play a game of trying to understand someone else's point of view um create these different scenarios and calculate with excel or a calculator how much would be owed at different points and kind of think to yourself you know if i were then what would i do in that position so a seller that sells a business and the buyer uses their own money a bank loan and a seller note well the buyer's down payment and all the money borrowed from the bank end up with the seller on closing day so often that's the majority of the money and then every month that goes by the exposure to the note is reduced for the seller and so i've had circumstances before where people have just walked away from unpaid balances because they got enough money and they didn't feel it was worth their effort to try to chase whatever amount was left over great question though um and so then we have another question this was from martin s who was watching the buy business with no money guru experience which i'll link to up here somewhere and he says from your experience what do you see as a healthy leverage deal how much money would the buyer have to bring to the table how much seller financing and how much bank financing this is a great question so traditionally amongst bankers they like to see a debt to equity ratio of three to one which means that the buyers putting about 25 percent of the money in now that doesn't necessarily mean that every buyer has to put 25 of the money down to buy a business other situations can arise if you're going to be using an sba backed loan if you're in in the united states then they may require you to put less money down there's also different scenarios where part of the seller's money might be considered to be equity by the lender so if a seller agrees to a note that has no payments for five years some sellers or some lenders rather will consider that equity left behind because there's no cash flow demand from that obligation and so there's different ways to massage these ratios but what i feel is the most prudent is for the buyer to put in enough money of their own to meet the requirements of the other lenders so that they're comfortable with the deal that usually means it can't be zero right it's got to be some amount of money as far as the bank goes i like to look at the tangible asset value um i don't really have a problem borrowing from an institutional lender like a bank for stuff that is real and presents a plan b of sorts if things don't go well you can sell the stuff and have money that you can use to pay back the bank when you sign a loan with a bank it doesn't matter what happens in the business you owe the money back to the bank and so people that get into trouble with business failure it's often that they're getting in trouble with these bank notes which is one of the reasons why i created a video a while ago called is seller is ninety percent seller event our 90 sba financing a good idea or something like that anyway we'll try to have a floating link here the seller financing is important to manage risk and i often say to people think about what the goodwill component is so if we're thinking about the tangible asset value with respect to the bank's note think about the goodwill component with respect to the seller note because the goodwill of the business is the difference between what you're paying for the business and the value of the tangible assets that's the airy fairy hot air portion of the business the reputation the fact that people know this business that they like this business etc it is the most fragile asset that you are acquiring when you purchase this business and if that goodwill is tied more to the owner than to the business's name it may not fully transfer to you you may pay for it and then people might not want to do business with you i'll give you an extreme example you know a hairdresser if a hairdresser has a little salon where they work there by themselves and they sell the hairdressing salon to me the loyalty of the customers might be to that individual person not to the business and so i could buy the business move in there and then no no the customers want to come to me for a hairdo because i don't have the same skill reputation or experience as the person who sold it so that would be an extreme example so i like to have seller notes relate in some way to the goodwill because if they're saying the business is worth this amount of money then the goodwill is worth this amount of money whatever the difference is with the tangibles and so that value if it really exists should be able to serve as collateral on that seller note and the seller should be willing to finance it now in some countries this kind of thing lines up pretty well and sellers realize that buyers can't borrow against goodwill and if the buyer can't get the money that it's going to have to come from the seller in other countries namely the united states of america uh government programs like the sba have totally messed up this market and so you could have a service business where seventy percent of the price is goodwill but the seller still expects to get ninety percent of their money on closing because other people are getting that because the sba is willing to do these these bank government guaranteed bank loans for 90 financing and to me it's dangerous because what ends up happening is all of the riskiness of that very ethereal asset the goodwill ends up on the shoulders of the buyer instead of the risk being shared with the seller and if a seller builds a business that is a big beautiful profitable business with lots of cash flow and and has lots of goodwill as a buyer you want to make sure that that seller is on board with helping to make sure the goodwill really transfers to you and that usually means transitional training but also coaching and mentorship which could go long beyond the period of what we traditionally think of as a training and transition period so in deals that i have worked on as a business broker in all but one the buyer and seller worked out a deal where there was a lot of seller financing like 25 30 40 50 seller financing and in almost all those cases except one that i can think of the buyer and seller have ended up becoming friends and the buyer and seller continue to talk to each other years after the deal was done they have a true relationship with each other where the buyer depends on the seller to help them run the business and the seller needs the buyer to be successful in order to collect on the note payments right so we create a symbiotic relationship between the two parties where they both have an interest in the success of the buyer which is where the risk resides sellers have many assets in addition to their business the buyer's the one who bears the risk in a transaction and so when the seller is on board with understanding the buyer's position and being supportive and wanting to give guidance mentorship etc that's when you have a successful transition and this is why i'm a huge preacher of there's got to be a significant seller note with meat in the deal for the seller that keeps them interested and tied to your success and if you want to know more details about just how important this is you really should sign up and enroll in business buyer advantage it's my online course it's like 13 hours or more of video lectures there's the audio files so you can repeat them in your car while you're out walking there's a 50 page workbook hundreds and hundreds of people have gone through business buyer advantage and i get emails every day from people who thank me because they've learned enough in the course to avoid bad deals which is my number one goal which is to help the two people to avoid bad deals through education anyway great questions fellas keep it up please comment on the videos send me emails with questions this is how i feed the pipeline of great content for you guys and i love you very much i look forward to seeing you next week cheers

Channel: David C Barnett Small Business and Deal Making SME

Views: 6,602

Keywords: business brokers, small business, mergers and acquisitions, small biz, entrepreneurship, entrepreneur, acquisition, investing, business, management, smb, vtb, seller financing, owner will carry, debt, note, owner financing, owner finance, seller finance, seller financing explained, buying an existing business, mergers and acquisitions basics, mergers and acquisitions explained, how to buy and sell businesses, business acquisitions, buy businesses, buying businesses, personal finance

Id: YhEs5CG3uGs

Length: 12min 47sec (767 seconds)

Published: Wed Apr 28 2021