Deal Structure

Buyer’s Source of Funds

Note: This only applies to businesses priced at $5 million or less.

Buyers of small businesses have four major sources of funds: Buyer’s personal equity, seller financing, bank or Small Business Administration (SBA) financing, and 401(k) rollovers.

Buyer’s Personal Equity

The buyer’s cash down payment either comes from cash on hand, other current assets (e.g., stocks, etc.), or equity in assets, such as real estate.

Seller Financing

The simplest way to finance the acquisition of a small business is to work closely with the seller and negotiate a “seller note.” The terms offered by sellers are usually more flexible and more agreeable to the buyer than the terms offered by a third party, such as a bank. Seller financing is also faster to arrange and requires less paperwork than traditional financing sources. Seller financing is often the most suitable option if SBA financing cannot be obtained. Morgan & Westfield handles the paperwork for seller-financing sales.

If you don’t offer seller financing and have to sell your business for all cash, be prepared to discount the purchase price. If you offer seller financing, your break-even point occurs about two or three years into the purchase. If you offer seller financing, think like a bank pre-qualifies your buyer and file a UCC lien on the business. 

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Bank Financing (SBA)

Nearly 95% of bank loans for the acquisition of a small business are SBA loans. The SBA does not loan money — rather, it guarantees loans made through banks. The SBA, through its 7 (a) loan program, helps small businesses access credit by guaranteeing loans made by banks in the event of a default. This limits risk for the banks offering such loans, which encourages them to lend money to small businesses. As a result, SBA financing can offer buyers attractive loan terms and interest rates while eliminating or reducing the need for the seller to carry a note. 

Click here for more information on SBA Loans.

Retirement Funds Financing

Most transactions are either financed using an SBA loan, a bank, or the seller. One additional source of financing for acquiring small businesses includes rollovers of retirement funds and seller financing. The buyer can avoid a small business loan altogether and use their retirement funds to finance the purchase of a business. Because the buyer is buying stock as an investment in their own company, the buyer doesn’t have to take a taxable distribution. 

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Financial Deal Structure

Note: This information applies to businesses at all asking prices.

The financial deal structure can differ from transaction to transaction. The following are the major potential components of a transaction.

Earnest Money

Earnest money shows good faith that a buyer is serious about purchasing your business. Buyers of mid to large-sized businesses rarely agree to an earnest money deposit.

Earnest money is usually held jointly by a third party or escrow agent. Funds are usually released only upon mutual agreement. If a buyer backs out, you may have to go to court to get the earnest money deposit returned if the buyer doesn’t agree to release it to you.

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Holdback

In a holdback, the buyer wants to protect themselves by “holding back” funds—that is, a portion of the purchase price—at closing. These funds will be released to you only after an allotted time and once a buyer is satisfied with their concerns. Holdbacks are usually held by third-party agents. Most holdbacks range from 10% to 20% of the purchase price. Holdbacks are more common in mid-sized transactions than in smaller transactions.

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Debt

It is important to understand what happens to debt when you sell your business, and that largely depends on how the transaction is structured. In some cases, the debt is absorbed in the transaction as part of the sale. However, this isn’t the case most of the time. In most instances, all debt is paid off at closing from the proceeds of the closing. There are two ways a transaction can be structured: as a stock sale or as an asset sale, and this, in turn, will determine what happens to debt at closing.

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Earnout

An earnout is a useful tool used in mergers and acquisitions and is commonly used by businesses in all different types of industries. It is an arrangement in which the buyer pays the seller additional money based on some metric, such as if the business performs well after the closing. Earnouts are a useful way to bridge a price gap between the perceived value the seller and the buyer each has for the business.

Be prepared to lose some of the money, as an earnout is not guaranteed. If you don’t have a good relationship with the buyer, the buyer will find a way out. Don’t agree to an earnout unless you trust the buyer 100%. Otherwise, the buyer will manipulate the terms of the earnout. Earnouts are more common in mid-sized transactions than smaller ones.

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Legal Deal Structure

Note: This information applies to businesses at all asking prices.

Asset vs. Stock Sale

From a legal perspective, a business is nothing more than a collection of individual assets, which are often owned by an entity, such as a corporation or LLC. When buying or selling a business, the transaction can generally take one of two forms: An asset or a stock sale.

  • In an asset sale, the entity (e.g., Corporation, LLC, etc.) sells the individual assets it owns (furniture, fixtures, equipment, customer list, etc.) to the buyer (usually the buyer’s entity). The majority of small transactions are structured as asset sales.
  • In a stock sale, the seller (e.g., John Smith, as an individual) sells the actual ownership of his entity (Corporation, LLC, etc.) to the buyer. This would be similar to you owning a share of Ford Motor Company and selling this share of stock to another individual. 

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Entity Type

The type of entity you have impacted the structure of the transaction and needs to be considered well in advance of starting the sales process. One of the primary considerations when determining how to structure the sale of your business is taxes. When selling your business, federal and state taxes can dramatically impact how much of the proceeds end up in your pocket. Whether your company is a sole proprietorship, partnership, or corporation will directly impact the type and amount of taxes that must be paid.

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Tax Implications

Note: This information applies to businesses at all asking prices.

Allocation

Allocating the purchase price or total sale price of a business among the various assets of the business (asset “classes”) is necessary for tax purposes when a business is sold, whether the sale is structured as a stock sale or an asset sale. Frequently, the allocation of the purchase price can become another area of negotiation after you and the buyer have agreed upon the price, terms, and conditions of the sale. In most cases, what is good for the seller is bad for the buyer, and vice versa, which can lead to contentious negotiations.

In the end, it is crucial that both you and the buyer compromise and meet somewhere in the middle to satisfy your respective goals. Once again, an agreement is required because allocations for both parties must match and be entered on the IRS form. 

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Non-Compete

When selling a business, most buyers expect the seller to sign a non-competition agreement (non-compete) at closing. Few buyers will purchase a business without a commitment from the seller not to compete after the business is sold.

The timeframe for most non-competes usually varies from three to five years. The geographic area covered by the non-compete typically coincides with the market area served by the business. For example, if a business’s customers come from a 5- to 10-mile radius, most parties will negotiate a 10-mile non-compete. 

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Lease Assignments & Transfers

The lease is an integral part of the sale process. Dealing with the landlord or transferring the lease can be one of the two biggest deal killers when selling your business, the other being your financials. It pays to properly handle the assignment or transfer of your lease. 

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