If you are just starting the process of purchasing a business then you have probably never thought of creative financing. That is what we are talking about in today’s podcast with host Jeff Allen and Morgan and Westfield President Jacob Orosz. In a business world that is tightening up on business funding, sometimes we have to get creative on how we can actually purchase the business we want.
It's hard if you don't know what you are doing but if you hire the right people, it's quick and easy.
- Jacob Orosz
Jacob: Good to talk to you, Jeff. How are you doing today?
Jeff: I'm doing fine, thanks so much. Jacob, what I wanted to talk about today was . . . I would like to talk about buying a business, but I want to talk about something that I just recently heard about and I know you probably have some thoughts about this. Is it possible that people can actually use their retirement funds to buy a business?
Jacob: It is possible. It's been possible for a long time.
Jeff: How easy is it for someone like me or anybody else who might be interested in buying a business to access their retirement funds for this purpose?
Jacob: It's hard if you don't know what you are doing but if you hire the right people, it's quick and it's easy.
Jeff: So, let's kind of walk through the process here a little bit. I'm interested in buying a business. What is the first thing that I would do?
Jacob: Well, we would refer you to a company that specializes in that. You probably want to have at least $50,000 in your retirement account. You do not have to have a business already identified and it's actually fairly quick and easy to see if you approve… certain plans that qualify, I think a Roth IRA does not quality but there are some qualifications. To be honest, I don't try to follow those to the letter. They change quite a bit. Just as in SBA financing. We stopped following these guidelines a while ago. We kind of keep our hands on it, our fingers on the pulse to some extent but we rely on experts extensively when we go to help people buy or sell a company and it's a fairly quick and easy process and a couple of companies that we work with, it's all that they do. They're experts on this process.
Jeff: This obviously gives me, I think, a great option and probably ready cash to go ahead and start the transaction. What about the closer, I mean, how do they benefit, the seller that is, how do they benefit at closing time?
Jacob: Well, if you're selling your company, let's say I'm selling my company and you're buying it and you use retirement funds to buy my business, I get all cash. I'm not going to have to carry a note. Yes, you can get into some creative deals structuring but if you are using your funds and using them to purchase my business, that's as good as cash. Another benefit for a buyer is if you're making an offer on a business, let's say you, Jeff, are looking to buy my hotdog stand, and you come to me and you want to make your offer contingent on bank financing, I'm probably going to put a lot of thought into that. I don't really know if I want to hold my business up for a month or two while you go to try to get financing. But, if you have already been approved to access your retirement funds, you make an offer on my business, that's one step from cash. It's almost as good as cash, so, in terms of negotiating, making an offer on a business and having a little bit of leverage over other buyers who want to finance to purchase the business, you're in a much better position.
Jeff: Oh, that's huge. And of course, the seller's going be anxious to probably do a deal with someone whose got ready cash lined up as opposed to those who are going to require financing or at least a majority of the purchase on finance. And so, I can understand that could probably be a real win-win situation, couldn't it?
Jacob: Yes. Absolutely. And it's a pretty streamlined process. It's relatively quick compared to trying to get bank financing, it's pretty easy. If you go to get a bank loan, unless you are a doctor - they like to loan to doctors, by the way, because they know if you don't pay the loan you're good for it because you can go get a job and make good money - but absent that, if you are going to get a bank loan to buy a business, you've got to do a ton of paper work. You've got to put together a business plan, projections and an application that's twenty or thirty pages long. And this is not just for the buyer, this is for the seller as well. So, if you are selling your company and the buyer's looking for financing, you've got a lot of work to do and you don't even know if the deal's going to get done. Whereas, if the buyer's using retirement funds, you have very little work to do in terms of the financing and it's going to be a much easier and more streamlined process.
It's a win for the seller. It's a streamlined process for them. It's a win for the buyer. Low fees, streamlined, high success rate.
Jeff: Well, Jacob, how often do these transactions go through? I mean, is there a high success rate with these?
Jacob: Once you are approved, yes. It's a pretty high success rate. I don't know the exact percentage but if I had to guess, it'd probably be between 95 and 99%. The companies that we refer these out to, they're experts, they know what they're doing. The people within the companies that do these are specialists. This is all that they do and they can look at the case and determine pretty quick after that if the buyer can access the money or not. If they say they can access it, it's a very high success rate versus if you're going to get a loan from a bank to buy a business, in the front end, when you go in to talk to the people in the bank, I think they probably get a bonus or something for getting an application. If you are actually talking to the loan officer or the approval committee, they could probably tell you in five minutes if you would qualify just asking you some quick questions and be able to pre-screen you but they don't pre-screen bank loans that way and frankly, it's really irritating. They want you to fill out the entire application and spend ten or twenty minutes of your time where, if you could only talk to the loan committee in five minutes, they could say, "look, this isn't going to get approved because your revenue's declined from the previous year." So, in doing this, it's a lot less stressful and there's a very high success rate.
Jeff: What about the cost, Jacob, on this...I mean, you're talking about cash sources, loan and financing, so, is there a huge, major difference I would imagine in the cost or the money?
Jacob: Well, the biggest difference is in the interest. It's your own money so you are not going to pay interest on it. It's probably about five grand or so to set it up. There's some fees. It is a retirement plan basically, so, there are fees associated with that but if you calculate the numbers, you could easily pay a hundred thousand in interest on a five hundred thousand dollar-loan over the life of a loan...
Jacob: And that's a ton of money versus in the long run, and you probably want to prepare some projections to compare the two options, but, you're probably going to spend a lot less money. The use of your retirement fund is just going to be a more intelligent decision.
Jeff: Jacob Orosz is the president of Morgan & Westfield and this is another one of our conversations with Jacob. Today we are talking about buying a business with retirement funds and yes, in fact, this is something that you can do and something that is being done more and more often all the time.
Jacob, you kind of alluded to creative deal structures a little while ago more toward the top of the show. Can you talk to us a little bit about, maybe, the advantage of a creative deal, why they're done and the kind of creative deals that we are talking about here.
Jacob: Well, if you're using. . . again, Jeff, if you are buying a business and you've got retirement funds, it's basically as good as cash, so, you can actually combine this with a bank loan to buy a business. We did a deal for about a million bucks and the buyer put down a hundred thousand of which all of it came out of his retirement plan...
The use of your retirement fund is just going to be a more intelligent decision.
Jacob: So, he didn't put up any of his own cash. Yes, it was cash in the sense that it was from his retirement plan but he didn't have to pull that out….
Jeff: Wasn't out of his pocket . . . right.
Jacob: So, that's ten percent coming from his retirement plan. The bank carried a note for eighty percent that was an SBA loan. And the seller carried a note for ten percent. So, we sold a business for a million bucks to a guy that put down no cash. I don't want to give people, like, crazy ideas “you can buy business with no cash down". It doesn't happen that often but this does allow the use of some pretty creative deal structures.
Jeff: What about credit scores, I mean, do those play a large factor?
Jacob: No, not at all.
Jeff: No credits are required because it's your money.
Jacob: Exactly, no credit scores are required. And also, subordination... If you're getting getting creative, say for example, two banks are getting involved, there's going to be a fight over whose subordinated and if you're a husband or a boyfriend you know what subordinate means. But, so nobody wants to be in second place. If you're using retirement funds, it's not an issue because it’s cash so there's really no issue with subordination. Again, no credit score required so, it's a simple streamlined process.
Jeff: What if I wanted to use, though, my retirement funds for maybe another business-related purpose, I mean, what if I wanted to buy some equipment or something like that?
Jacob: Once the funds are rolled in there, into the retirement plan, they can be used for a multitude of purposes or for any business purpose. There's not a lot of limitations. It can be as for working capital or purchasing equipment or really any other legitimate business purpose.
Jeff: Obviously, one thing that kind of jumps out at me is that when you use your own money, there's no debt.
Jacob: Yes, there's no debt. Some people are opposed to debt. Again, Jeff, if you're buying a business for a half million and you're borrowing four hundred thousand, you're creating four hundred thousand in debt. But if you're using your retirement funds, there is no debt so when you go to bed at night, put your head on the pillow, it feels good knowing that you don't have any debt.
Jeff: Well, let's talk about maybe some of the other advantages in terms of the interest that you're paying. When you're using more of your money, there is less interest that you have to pay, so, it seem to me that where cash flow is concerned, that could be a real benefit.
Jacob:Absolutely. It's easier to crunch the numbers and make a deal happen because the buyer doesn't have to pay interest. In terms of seeing if the deal works and looking at how realistic it is and if you can just justify the numbers, in a typical deal, let's say that the cash flow is two hundred thousand a year in terms of profit. If you're paying out a hundred and fifty thousand per year in interest, for the bank loan you're only left with fifty. And that deal probably isn't going to work. But if you're using your retirement funds, it makes for a leaner deal structure and in terms of structuring the deal and being creative, you're more likely to get the deal done because there's no interest to pay.
Jeff: What about tax benefits, Jacob? Can you share any of those with us?
Jacob: Well, for a bank loan you can deduct the interest. If you're using your retirement funds, you have all the traditional benefits of a retirement plan. I don't want to go into those . . .
Jeff: Okay . . .
Jacob: …You can talk to your CPA about it. It’s complicated. Those rules change quite a bit but you have the tax deductibility of those funds. And also, once that fund is set up, you can invest more money into it, tax deductible as well.
Jeff: It would seem to me that this is probably, just for all the usual reasons, this is something that only individuals could take advantage of, is that right?
Jacob: That is correct. If you think your business could be sold to a larger corporate buyer or a private equity group, this really wouldn't apply. This is for smaller market deals. Probably under a few million. You might be able to go beyond that. But if you've got a business that's valued at ten million plus, this probably doesn't apply to you.
Jeff: Anyway, to what we're talking about here, this is not to say that it's not a good idea to use bank financing. That's used every day. That's pretty much the modus operandi. The point is this is an option that is available to you but that bank financing is really still something you need to look into.
Jacob: Yes, that's a good point. It's an option. If I've got two buyers, Jeff, if I'm selling my business and I've got two buyers and Jeff made an offer and he's got his retirement funds that he's using and I've got another buyer, say Rob, that wants to get financing for my business and all things being equal, I'm going to take the offer from you, Jeff. Hopefully, that makes you happy. Bank financing is still a useful tool. Of course, it's a 7(a) loan, the SBA 7(a) loan. It's usually used but this is just another tool in your arsenal and they're all great tools to use and bank financing as a tool should not be discounted.
... in terms of negotiating, making an offer on a business and having a little bit of leverage over other buyers who want to finance to purchase the business, you're in a much better position.
Jeff: I want to kind of jump back over to talk about costs that are associated with this. And that fifty thousand dollar minimum, what if I have less than that, I mean, in terms of which way I should go? Is it just as cheap, probably, better off if I just go through it and go to a bank at that point?
Jacob: Yes, go through a bank or just pull out the money and pay the penalties. Obviously, when you have money in your retirement plan and if you pull it out early, there's taxes and penalties and so forth. And by the way, with this set-up, if you use the money to purchase a business, there are no taxes or penalties but if you've got less than fifty grand, just pull it out and pay the taxes and penalties. That's probably cheaper to do it that way.
Jeff: There you go. So, let's go ahead then, Jacob, and talk about how the process actually works. What has to happen, tell us, just kind of give us the kinds of nuts and bolts in that.
Jacob: It's complicated. You don't want to do it yourself. If you screw it up, you're going to be in some pretty deep trouble but if you set up a C Corp, a C Corporation, the C Corp creates stock, doesn't issue it yet. Then, it forms a profit-sharing plan and the buyer rolls over their existing retirement money into that new account, into that new profit-sharing plan. That money is, then, exchanged for the newly issued shares in that C Corp. That cash, again, can be used to purchase a business or any other corporate assets and again, don't do this alone. Let me put that simply. Basically, what you're doing is you're taking your money in your retirement plan and you're rolling it into a new plan and then taking the money in that new plan and using it to buy stock in that new entity. Just as if you're working in the job and you have your retirement money and you're investing in Ford or Microsoft or Google or Facebook or any other stock, you're just rolling it in the new plan and you're investing it into the stock of your own business. Again, don't do that alone.
It's complicated. You don't want to do it yourself.
Jeff: Yes, it is a little bit more complicated than really meets the eye or at least that it looks on the face of it and particularly, when there could be penalties that apply that, from the IRS, if you don't go ahead and take the measures to consult with someone who knows about these things and a professional. So, I think that warning is warranted quite frankly, Jacob, and I appreciate that. What is it about this plan, what is it about the strategy, Jacob, that you like so much?
Jacob: Win, win, win. It's a win for the seller. It's a streamlined process for them. It's a win for the buyer. Low fees, streamlined, high success rate. And for us, as well. If we're involved in the deal and we're helping, me, personally, I look at that basically as cash and again, if bank financing is involved, we don't like to lock up a business and take it off the market for a month or two months or three months. We're not just comfortable doing that. So, it's a winning situation for everybody involved in the process.
Jeff: Jacob, what if people have questions and I know that they probably will because this may be new to some folks. What should they do?
Jacob: Give us a call. Send us an email. info@morganandwestfield where you can call me directly at 888.693.7834 and will see if we can help you out.
Jeff: Jacob Orosz, president of Morgan & Westfield. Thank you so much. Good to talk to you again.
Jacob: Thank you, Jeff. I appreciate it.
Jeff: If you'd like more information about selling or buying a business, perhaps, using retirement funds, call Morgan & Westfield at 888.693.7834 and you can also visit their website at www.morganandwestfield.com. We'll have more in this series of ongoing conversations with Jacob Orosz so stay tuned for further episodes. My name is Jeff Allen, thanks for listening.