The Individual Buyer
The individual buyer category encompasses a variety of buyer types that include wealthy individuals, corporate executives, engineers and salespeople working for large firms, and foreigners who have recently moved to the U.S. The individual buyer category represents the largest number of prospective buyers for small to midsize businesses.
Wealthy individuals often are people who have taken early retirement from corporate America and after a brief period of rest decide to get into their own business. They tend to acquire smaller companies grossing in excess of $2 million.
Corporate executives, engineers and salespeople make up a large portion of those who buy small to midsize businesses. They are often driven to buy their own business due to events in their corporate life such as being asked to move to another city, loss of their job due to corporate mergers or downsizing, being passed over for promotion or fed up with corporate bureaucracy. They tend to buy businesses that gross $2 million.
Small Business Administration 7A Loan as a Finance Option
Long term financing is usually arranged through banks and mortgage companies in the form of the Small Business Administration's 7A loan guarantee program. The SBA loan guarantee programs enable financial institutions to make loans to individuals or companies with individual guarantees up to $1,600,000 wherein the buyer must put up 25% to 35% equity on non-real estate type loans and 15% to 25% where real estate is part of the transaction.
The assets being acquired and the personal guarantee of the borrower typically secures these loans. Owner financing is considered by the SBA as equity funds, but seller financing cannot exceed the buyer's equity contribution limiting seller financing to no more than 15% to 20% of the transaction price.
For a target business to qualify for a buyer being able to obtain a SBA guaranteed loan to finance the tangible and intangible assets of a business, it must have been in business for at least three years and be able to provide three years of tax returns showing sufficient profits to repay the buyers loan and provide the buyer with a livable salary. Adjustments to the reported earnings are allowed for provable expenses that are either non-reoccurring or personal in nature.
A significant portion of transactions involving small to midsize target firms are seller financed. This is usually due to the target company's poor financial record keeping or when the business has been in business for less than three years. Most every business owner has heard of a transaction where an owner provided financing for the buyer and the buyer destroyed the business and defaulted on the loan. In most cases, the terms of the financing would have predicted the failure. A high price, low down payment, and/or short-term payout often contribute to note failures.
Transactions properly structured are usually successful. In fact, after a seller-financed note has matured for six months to one year, there are several national companies who buy owner financed notes. Typical owner financing includes a reasonable selling price, a down payment of 30% to 45% and a payout of 5 to 7 years, with interest rates starting at prime plus 2%. The assets of the business being acquired and the personal guarantee of the buyer typically secure the note. A lien showing the note security is filed with the Secretary of State or required public records. Furthermore, the terms of the note should allow for the note holder to invoke rapid foreclosure proceeding in the event of default.
- Target companies typically have gross revenues up to $5 million.
- Buyers tend to seek businesses that provide products and/or services that are easy to learn without long periods of training and high costs of entry. Many retail, service businesses and wholesale/distribution, meet these criteria. Businesses requiring professional licensing are usually limited to buyers who either have the license or can get one without incurring major costs or time delays.
- Most individual buyers seek businesses that have current earnings at least similar to their most recent salaries, and upside potential for earnings growth. Buyers look for business that have good growth potential, but they are not willing to pay a price based on future potential.
- While financial results are important, other lifestyle considerations can be equally important.
- Location of the business in proximity to the buyer's home is often a significant consideration.
- The business must have "curb appeal." The condition and appearance of the equipment and facilities must be appealing or at least not unappealing. A little paint and attention to cleanliness goes a long way towards making a business attractive.
- Businesses with full time employees give buyers confidence that the business has continuity and stability. Having employees who can run the daily operations is more appealing than those businesses that are highly reliant on the owner to make daily operating decisions or have personal relationships with the company's customers.
- Businesses that have verifiable and current financial records enable a buyer to quickly do their due diligence and obtain sources of financing. Most lenders require copies of the last three years of tax returns and a year to date financial statement within 60 days of the acquisition.
- While buyers may not always know the latest techniques for valuing businesses, they are capable of determining if the business makes sufficient earnings to earn a livable salary, pay the new debt service and provide a reasonable return on the investment. Ultimately, these factors are the test to see if the price and terms of any deal are reasonable.
"Thank you for enabling us to sell our Florida division in a win-win fashion...that's the manner in which business is meant to be conducted."