The current credit crisis is keeping business buyers and sellers from coming to the table, but an often dismissed solution can be the answer to getting a deal closed.  It is seller financing and when done correctly and under the right circumstances, it offers sellers a way to get a market price for their business with minimal risk of nonpayment.  For buyers, it provides an opportunity to purchase a business that might otherwise be unattainable.  So, instead of letting the credit crunch put a crimp in your deal making, learn how to use seller financing to your advantage.(more)

If your business is stressing you out, you consistently work more hours than you want, or you worry about leaving your business for more than a couple days, it is a strong sign that your business is not working for you.  Often the issues causing stress, long hours, and the inability to get away can be readily solved, as this article will illustrate.  However, be warned that it is far easier to understand what to do than it is to do it. (more)

Type: Business-to-business, manufacturing and distribution preferred.

Type: Manufacturing or Distribution in the Powersports Industry (no retail).

In addition to promissory notes, seller financing comes in many forms; such as higher than market lease arrangements on real estate or equipment, performance based earn-outs, royalties, employment agreements and consulting contracts.  The problem is that these approaches alone can’t always overcome the financing gap caused by tightening lending requirements, increasing the need for non-contingent promissory notes.  Sellers and buyers that are careful to ensure their deal meets two essential criteria can have great success using non-contingent promissory notes.

Fairness of the deal is the first standard.  While a promissory note is not contingent on the performance of the business purchased, a buyer’s ability to service debt typically is.  Sellers must be willing to negotiate with buyers to create a workable deal structure.  Sellers planning on selling their note may dismiss this standard, but this mistake will likely mean their note will only be sellable at a large discount, if at all.

Though some sellers will hold a buyer’s promissory note, the note should be “underwritten” for the purposes of being sold on the market.  Sellers following a strict underwriting procedure like that used by banking institutions will not only increase the likelihood of getting paid if they keep a note, they may sell their note for as much as ninety-five percent of face value.  If a note is for half of a purchase price and discounted as much as twenty percent, it is still only a ten percent discount on the total price.  For cash in the pocket, this is a trade that is often well worth making.

Sellers and buyers considering the use of a promissory note should understand how deal structure and promissory note attributes affect its market value, which is why general guidelines are presented below.  However, those considering promissory notes would be wise to talk with their banker or other finance professional to help them develop their underwriting guidelines and documentation needs.  

The two primary issues related to deal structure are equity invested and debt service ability of the company.  The more equity invested, the harder it is for the buyer to walk away, reducing the risk of non-payment.  Also, more equity can mean greater collateral coverage, which also reduces risk.

The ability of the company to service all debt is the other key deal structure variable.  Sellers that structure deals that won’t allow for the correct debt service ratio will have a hard time selling their note and those that are successful will have to take a large discount.

With regard to the note itself, there are a number of factors to consider.  Firstly, the amortization schedule.  The shorter the term and the more principal paid monthly, the more valuable the note.  However, if it is too aggressive, the company may not be able to service the debt.  So the key is to find a good balance and to avoid balloon payments if possible.

Another factor is the interest rate.  Sellers often want the notes with very low interest rates to reduce taxes, but notes with low interest rates will be discounted further to make up for the low rate.  To avoid having to discount, a promissory note should have an interest rate commensurate with market conditions.  Prime plus three percent is often a good benchmark.

Collateral is another consideration.  Obviously, the higher the collateral value to debt ratio the lower the risk.  Collateral with a predictable, stable value is preferred greatly.  Further, it is always better if the debt is unsubordinated as the note buyer will highly prefer first position.  Be sure to know if the collateral is already pledged or if there is a UCC filing against it as this will significantly diminish its value.
 
Personal guarantees are likely to make the note worth more too, particularly if there are additional sources for repayment.  However, even a weak personal guarantee helps as it offers note holders additional options to enforce payment.

In addition to note specifics, the background and credit history of the buyer providing the note will be scrutinized.  An excellent work history with a background conducive to success in the venture will be important.  Of course, a good credit rating is essential.
It should also be noted that in some cases the seller can improve the value of a note by providing a loss limit to the purchaser.  This sometimes requires either pledging assets or setting-up an escrow account.  In addition, a note with a history of payment associated with it will likely increase its value, so a seller may consider holding a note for a while before taking it to market.

In today’s credit climate, buyers with the right background and great credit history can use this knowledge to purchase businesses that are difficult to finance, particularly if the seller is having difficulty selling the business.  For buyers this can mean a reduction in purchase price that more than offsets the added cost of a slightly higher interest rate.

Business sellers that offer seller financing can significantly improve their likelihood of completing a transaction.  If the financing is offered only under strict underwriting guidelines, sellers can sell their notes at anywhere from a five to twenty percent discount, which means they can typically receive ninety percent or more of the sale proceeds in cash. (top of page)

Chances are you had a reason to go into business.  Perhaps it was to control your future, to live a specific lifestyle, or to build an organization.  It is also possible that you never gave it much thought.  Regardless, as your business grows it is of critical importance to know what you want out of your business because a disconnect between what you want from your business and what you are actually getting is often the source of frustration and stress.  Therefore, the first step in creating a rewarding business ownership experience is to be clear about why you are in business.  It is from this understanding that “vision” is created, which provides the basis for business development and the role an owner plays in the organization. 

Many years ago I worked with an individual that wanted to start an aviation company.  His goal was to be a charter pilot, which meant his company was about a lifestyle.  He didn’t want to get big; he just wanted to make a living doing something he enjoyed.  However, his success soon lead to expansion and his vision began to blur.  At first he was excited about the growth, but after a while he dreaded going to work.  It wasn’t until he re-evaluated why he was in business and scaled back that he started enjoying what he was doing again.  His organization was again in alignment with his vision.

The initial development of any business is similar.  At first, the owner may work at the business part-time until critical mass has developed and they can make it a full-time endeavor.  Then the business grows further and it becomes difficult to do alone.  The first employee is hired, typically to allow the owner to focus on more critical tasks or a specific aspect of the business.  Then another employee is hired, again allowing the owner to focus more on certain critical tasks.  This pattern then repeats itself and the organizational pyramid grows sometimes two or three layers deep.

Business owners that reach this level often find themselves overwhelmed and stressed.  A common complaint from owners is that they feel that if they are gone for more than a few days the business will struggle and major problems are likely to arise.  This is one sure sign that the business owner either needs to inhibit growth of the business or adapt to the leadership requirements of a growing company; often a difficult choice.

Sitting on top of the pyramid is often what a business owner really wants.  Mostly because it provides the job they want.  They are on top of the pile, making decisions and controlling most aspects of the business.  For those that are about control, this is perfect; until it becomes too large.  As the pyramid grows and the company becomes more complex, it requires greater leadership and management skills.  Eventually the growth will require the owner to change their role in the in the organization, which is often the cause of dissatisfaction. 

Business owners that want a particular lifestyle from the business need to be careful not to let the business control them.  The pressure to grow can be enormous, but at a certain point these owners should concentrate on making their business better and more profitable so as to maintain the correct size and lifestyle. 

For those that want to grow there is a different challenge.  Business owners with highly effective management skills can grow the pyramid two or three layers deep.  However, as long as they are on top of the pyramid and performing a day-to-day activity in the business there will be a limit to how far they can go and to the value of their business.  It is at this point that an owner must learn to “flip the pyramid.”

The concept of flipping the pyramid is very easy to understand.  Instead of being on top of the pyramid, the business owner must conceptually flip it upside down so that the pyramid stands on its tip and the owner is on the bottom supporting the organization.  No longer is everything flowing up through the funnel at the top, but instead the pyramid gets ever wider and the role of the owner is then about supporting the organization.  This configuration allows the company to expand exponentially as it provides everyone with the opportunity to contribute towards growth. 

A major difficulty with flipping the pyramid is that it requires a complete change in the role the owner plays in the business and the new role requires different thought and behavior that is usually at the polar opposite of what it took to make the business successful in the beginning.  Behavioral change is one of the hardest things a human can undertake.  Seemingly simple, slight changes can be nearly impossible.  If you are obese, eat less.  Seems easy, but we all know it is not and the millions and millions of dollars spent on such behavioral change bears witness.

If you are feeling stressed or frustrated with your business, the first critical step is to develop an understanding of what you want from your business and to create a vision that is in alignment.  This vision will provide the basis for decision making and organizational management. 

If your goal is to grow your business to its greatest potential, know that you will be challenged by the need to continually change your role in the company.  Many business owners that have successfully made the transition will tell you that it was the hardest thing they have done in their life, particularly if they have had little or no experience in a larger company.  But they will also tell you that it is rewarding and possible if you are willing to change as your organizational needs change.

The changing roles and strategic initiatives associated with success in “flipping the pyramid” will be the subject of the next Lessons from Twenty-Five Years to appear in the fall issue of Owner’s Equity. 

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