By Richard Parker, President of Diomo Corporation. Richard is the author of several books and, has over 100 published articles to his credit on buying and selling businesses. He is one of the country’s most successful mid-market mergers and acquisitions professionals.

Deal Terms You Can Expect

When it comes to selling a business, there are a number of scenarios that you may encounter that involve far more than just the purchase price. You may also come across terms that are new to you. The good news is that despite the number of possibilities, they are all fairly “standard”. There are really three main areas that you want to be aware of prior to selling the business:

Purchase price and how the value of the business is established
Financial terms
Performance clauses and Earnouts

Purchase Price/Valuation

As you can probably imagine, the value that you have for the business will likely differ from the buyer’s assessment. The first thing to understand as a seller is that whatever you think the business is “worth” is not necessarily the “value”. You have an emotional investment in the entity. Your years of hard work are tied to it and so naturally, to you, that is “worth” quite a bit. However, a buyer will initially look at the business strictly from a logical perspective and will determine a value based upon the provable historical financial data, industry comparables, asset values, and return on investment, etc. As you can see the spheres of logic and emotion are operating independently.

The objective of course is to get the two perspectives to intermingle; meaning that you the seller need to understand what is logically a proper value for the business, and the buyer may need to lessen their rigidity and look to some of the benefits of owning the business and thereby be willing to pay a reasonable premium for a solid business they can grow.

All this is easier said than done!

If you do not have experience in business valuations, then you clearly want to engage competent professionals to do so. You can have a formal valuation done, but those usually only apply in larger sales plus, they do not always reflect the real world. Nevertheless, they can be an excellent learning tool and basis from which to begin. Your accountant can assist you, however they generally place too much emphasis on the Balance Sheet for valuations whereas a small business buyer is looking for income and therefore will pay more attention to the Profit & Loss Statements (P & Ls). A business broker will generally utilize a more simplistic approach and may over emphasize what it will take to sell the business quickly. However, any good broker will likely provide you with a much more realistic valuation based upon the general market versus other sources. It does behoove you nevertheless, to consider having a valuation done from all perspectives since valuations are an art, not a science and with a range of opinions you will be in a much better position to deal with the buyer and your expectations will likely be at the right level.

Above all, the market will dictate the valuation of your business so if you overprice it, after going through an extended period of no offers or “low balls”, you will begin to see what the market will bear. If you’re way off, you may need to adjust your thinking.

Financial Terms

There are three basic possibilities for the actual deal terms: all cash, seller financing, third party financing

All Cash

Although the concept that a potential buyer will write you a big, fat check for your asking price is enticing; it’s highly unlikely. All cash deals only happen in a small percentage of small business sales and the seller will usually have to take a “haircut” of 15 to 25 percent off their asking price. While these deals do happen, it is not common.

Seller Financing

You undoubtedly have to make a decision about financing part of the purchase. This is not usually too attractive for a business owner. The main fear is you will not get your money, and that can happen. However; seller financing does represent the majority of deal terms and by offering it you can absolutely obtain a better purchase price from the buyer.

Terms usually average around five years at around prime or prime plus one or two percent. The business assets that you are selling will typically be your collateral although the buyer will sign personally. They usually will not provide collateral or secure the loan with their own assets.

While there are no hard statistics, the amount of seller financing averages around thirty to fifty percent of the purchase price with the percentage declining as deals get larger. In other words, the smaller the sale price the greater the amount of seller participation usually. This makes perfect sense since the margin of error and risk in the buyer’s eyes increases for a smaller business.

Personally, I have never been opposed to providing financing to a buyer for any of the nine businesses I have sold but that’s after heavily qualifying them as being capable to operate the business. I always got a higher purchase price. Luckily, all of the situations worked out well and I was paid in full (not always on time I must admit) but no lawsuits or anything of that nature; just a bit of grinding and patience from time to time.

Third Party Financing

I don’t know about you but I get an onslaught of solicitations from my own bank about all of their “fantastic” programs that can help small businesses. The big banks have done a wonderful job of marketing and conveying the impression that their vaults are wide open for entrepreneurs. As you know, that is definitely not the case. The problem is that most business buyers don’t know it; but they’ll learn quickly.

Having a traditional lender provide financing to a buyer happens, but in less than ten percent of small business purchases. The SBA has some excellent programs but the criteria for both the business and individual make it a little more difficult. In any event, it is well worth you investigating what criteria your business may need to qualify because if it does it will make it far more attractive to many more buyers. If you engage a business broker they will work to get the business “pre-qualified” for an SBA loan which again will increase it’s attractiveness amongst other business for sale listings (learn more about the SBA 7(a) programs at www.sba.gov). As a final note on this point, if you have the luxury of time, work towards implementing the steps that will ultimately qualify your business for this type of financing.

Performance Clauses and Earnouts

In some transactions, part of the purchase price may be tied to the business’ future performance. This generally happens when:

The business has experienced a recent surge in revenue/profitability and the buyer wants to be certain it is sustainable
The business has recently landed a significant future contract and the seller wants to receive the benefits of it in the purchase price.
There is a large percentage of the company’s revenue tied to a very limited number of clients. Should any of them no longer remain a client after the sale, it can significantly impact the business
The business has been in decline but measures have been taken to get the business back on track.

If you tie the purchase price to future performance is a way to deal with all of these situations however; the conditions can be cumbersome unless there is very detailed and specific language to measure the results.

Summary

As you can see, there can be a lot more to the purchase price of a business than one would think. Each deal is different and ultimately, the simpler the deal terms are, the more flexible the parties remain in reaching agreement. The more open minded a seller is to making it “easy” for someone to buy, the greater the chances that you will bring it to a successful closing.

About the Author
Richard Parker is President of Diomo Corporation (www.diomo.com) and founder of Diomo Solutions, LLC (www.diomosolutions.com) He is the author numerous books and articles on buying and selling small businesses which are sold in over 70 countries. He is also one of the leading business intermediaries in The United States assisting both buyers and sellers. Mr. Parker has personally sold nine of his own businesses since 1990. You can Email Richard with any comments or questions you may have about selling a business or to learn more about his intermediary services.

This article is © Copyright 2006 by Richard Parker and may not be reproduced in any format whatsoever without prior written consent of the author.

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