When it comes to buying a business, your options to finance the purchase have become far more diverse than ever before.
Although there have always been numerous ways to finance the purchase of a business, the Covid-19 disruption forced sellers to consider alternative payment methods or risk losing suitable buyers.
In today’s small business market, the financing method a buyer proposes has become an integral component of the overall offer to purchase.
No longer is it assumed that the offer will be either cash or bank finance, as it was just a couple of years ago. And this modern way of payment is doing wonders for the small business market in Australia.
This article looks closely at the 5 most common financing methods in the market today and some of the strengths and weaknesses that each one brings. These are:
- Cash Purchase
- Financed Acquisition
- Earn Out
- Buy-Out
- Retention
1. Cash Purchase
Firstly, the traditional and safe cash purchase. Hopefully, this method needs no explanation; you pay for the business with money in your bank, and the saying cash is king still reigns true. In addition, having the capital to purchase gives you the leverage to negotiate harder.
1. Financed Acquisition
This method has several sub-categories. The traditional way was financing from a bank or other lender. However, vendor financing has become an extremely popular method of buying a business.
This approach entails the vendor becoming the lender. To take advantage of this approach, the vendor needs to be agreeable with vendor financing in the first place.
The main terms to negotiate are deposit vs loan amount, interest and term. Usually, the vendor will have a minimum requirement for the deposit.
The buyer’s circumstance might be that traditional lenders will only approve them for $150,00, but their expertise, knowledge or relationship with the vendor gives them confidence that they’ll meet their payments as structured in the loan agreement.
Defaulting on vendor finance can be pretty severe depending on the loan agreement, so there are many protections for the seller.
3. Earn Out
Earnouts have gained popularity for one main reason. It transfers some risk back to the seller if the business does not perform as initially assured. You can imagine how hesitant buyers have been these last couple of years trying to determine what a typical year of trading looks like for that business.
Two factors make earnouts unique; firstly, when the buyer is acquiring a company, the staged payments are equivalent to the transfer of shares for that payment. For example, 50% of the purchase price transfers 50% of the shares.
Secondly, the vendor is usually required to stay in the company for some time to ensure business continuity. As a result, earnouts appear at the medium to the larger end of small business sales, usually around the $1,000,000 price tag and up.
An earnout must be documented and signed by both parties as a condition of the sale. The benefit of an earnout agreement to the seller is that they usually achieve a higher price than a cash purchase.
4. Buy-Out
Buy-outs have been a common strategy for a long time in larger enterprises. A buy-out refers to one party or group of people buying a controlling stake in a company or business.
The buying party has no requirement to purchase all 100% of the enterprise, and the vendor is not required to meet targets or retain their new level of ownership if they choose not to.
You may have heard of management buy-outs, and often, the potential buyer will submit an offer to the board of the targeted company. After some negotiations, the voting shareholders will decide whether to accept the proposal.
It’s a targeted strategy that allows for an acquisition without the business going to market.
5. Retention
Retention is another strategy that shifts some risk from the buyer to the vendor. The difference is that the buyer takes full ownership of the business and its assets on settlement.
However, the vendor only receives part of the sale price, with the remaining retained in a solicitors trust account until certain conditions have been met.
Again, these conditions can vary, but the retention clauses are usually drafted in a way that makes it far more advantageous for the buyer to pay the seller the remaining funds than keep them due to poor business performance.
If you want to know more about what the best sale structure will be for you or what’s involved with selling your business, then get in touch with the details below.
I help my clients successfully exit their business at the highest price, in good time, and without stress.
Next Steps
If you would like some advice about selling your business, you can contact me:
- Call on 0416638154
- Email at mick@mickgodwin.com.au
- Booking a Strategy Call in my calendar.
