Many years ago, a friend of mine came to me with an intriguing business problem. He had long wanted to start his own business. He decided he wanted to buy either an existing business or a franchise, the thinking being that he didn’t want to have to start a business from scratch.
When we looked at franchises, it became apparent that a franchise wasn’t going to work for him for two reasons. First, he really wasn’t the type to take direction well, a requirement for being a franchise. Second, most franchises were beyond his financial capacity.
Buying an existing business
So he decided to buy an existing business. Generally speaking, buying an established business is a good idea for several reasons:
- First, there is less risk. You can review the books of the business and get a pretty good idea as to how much money you can expect to make
- Second, there is the built-in clientele
- Third, you do not have to spend years creating a brand; goodwill is already established
- Finally, it is sometimes possible to get the present owner to stick around for a while (six months or so) in order to teach you the business.
My suggested solution was that, beyond finding an existing business, that he specifically look for one where the owner was willing to help finance the purchase. This sort of financing is well known in the real estate industry where the owner agrees to “carry the paper” for the buyer. The homeowner’s note is usually recorded as a second mortgage and is paid off in due time. The same idea is at play with owner financing in the sale of a business. The owner carries the paper and is paid off over time.
Why would a seller help finance the purchase of his business?
Usually, a business owner will finance the sale of his or her business for one of several reasons:
First, it might be a slow market or bad economy. Seller financing can help expedite a sale in those circumstances.
Second, it could be that it is not a great business. If the seller cannot sell the business the old-fashioned way – via a broker and getting the buyer to pay 100 percent – it may be because the business is sort of like a car that is a lemon. The owner figures that financing the business will at least make it someone else’s lemon.
Finally, and this is what we looked for, there are times when a seller is, as they say, “highly motivated,” and so helping out the buyer financially with the sale helps move the business faster. It may be that he’s getting divorced and needs cash or, or that she is ready to retire and move to the Bahamas and wants to cash out. Whatever. The seller needs cash now.
How it works
In my friend’s case, we found a good business that was listed for $65,000. The owner had been given the chance to teach overseas and wanted to sell the business pronto. The problem was that my friend only had $25,000 and didn’t qualify for a $40,000 business loan.
But we convinced the seller to carry a $25,000 note and that carried the day. My friend was able to put $25,000 down, the owner carried a note for another $25,000, and then we were able to get him a $15,000 bank loan to cover the balance.
By offering a motivated owner a way out, a chance to sell the business if they carry some paper, you become a solution to their problem.
Are there risks? Of course, this is business after all.
The main risk is that the buyer will default on the loan and the owner will be forced to repossess a business he no longer wants. But a business owner can reduce the likelihood of that happening by doing some due diligence. The seller must check out the buyer as much as the buyer must check out the seller and the business.
But the good news is that once everyone agrees that the other party and the business are on the up-and-up, then seller financing is a creative way to solve everyone’s problems. In the case of my friend, he still owns that business to this day and makes a very good living with it.
And the previous owner? She made 12 percent on her $25,000 over three years. Not a bad deal for all concerned.
About Steve Strauss
Steven D. Strauss is one of the world's leading experts on small business and is a lawyer, writer, and speaker. The senior small business columnist for USA Today, his Ask an Expert column is one of the most highly-syndicated business columns in the country. He is the best-selling author of 17 books, including his latest, The Small Business Bible, now out in a completely updated third edition. You can also listen to his weekly podcast, Small Business Success.© Steven D. Strauss.
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