Financing is the glue that makes business transactions possible. The lack of it causes deals to fall apart, business expansions to founder and the joy of being an entrepreneur less gratifying.
In order to explore cutting edge ideas about transactional financing, small-business owners, buyers and sellers, franchise practitioners, intermediaries and U.S. Small Business Administration’s resource partners, attended a webinar called “Best Practices in Buying and Selling a Business with a Focus on Financing.” BoeFly.com, the premiere online marketplace for borrowers to meet the most active lenders, presented the event on October 17. Mike Rozman, BoeFly’s co-president moderated the panel of experts.
“You’ll find BoeFly a terrific source of all kinds of education and information that can really get you ahead of the game,” said Beth Solomon,” vice president of the International Franchise Association who kicked off the event. “The IFA and BoeFly have a strategic alliance in which we’re working together to offer tools and solutions, good advice, counsel, information that our members can use to advance in franchising, especially on the financing side.” BoeFly and IFA created and maintain the IFA/BoeFly Franchise Lending Index to track trends in franchise financing activities. BoeFly.com has over 125 franchise brand members that direct their franchisees to the site for financing.
With Solomon throwing down the financing gauntlet, Curtis Kroeker, vice president and general manager of BizBuySell, picked it up and said that the lack of adequate financing is the “single biggest factor that’s holding back small business transactions.” His online company lists about 45,000 small businesses for sale and receives over 825,000 visitors per month. They also published The BizBuySell Guide to Selling Your Small Business which can be downloaded for free.
Even though banks are making acquisition loans available for the right deals, “seller financing is a key way the sellers in today’s market are really differentiating their businesses and really helping to get deals done,” Kroeker says.
But compared to the much larger volume of small and medium-sized business acquisition activities before the Great Recession, seller financing is not enough. To increase the volume, financial institutions must feel more optimistic about the economy, the government’s fiscal discipline and pending regulatory rules that have yet to be written. Until then, lenders will continue to cherry-pick the best deals and more marginal applicants will be cast aside.
Bankers underwrite the business being sold as well as the purchaser’s ability to continue its current cash flow, increase profits and repay the loan. “For us,” says Tony Kim, vice president with Brookfield, Wisconsin-based Ridgestone Bank, “it’s weighted so heavily on the buyer, his experience, his background.” Tom Abraham, also a Ridgestone Bank vice president, added, “We believe the borrower has to have some liquidity going into the deal in terms of working capital and startup costs.”
The amount of liquidity and down payment required will vary from lender to lender and deal to deal. In general, however, a 20 percent to 30 percent cash investment from the borrower is an industry standard. Some lenders, such as Ridgestone Bank, will consider seller financing as part of the down payment when it is subordinated to the bank financing and structured to complement the lender’s senior position.
Lenders also look at the subject company’s market value as well as the resale value of its collateral, should liquidation become necessary to repay the loan. Accordingly, Neal Patel, certified business appraiser and principal of Cranbury, New Jersey-based Reliant Business Valuation, told the attendees that the rules of thumb can come in handy to ballpark a company’s value. “The price to earnings multiple is pretty simple,” he said. For example, if an “earnings stream is $100,000.00, a two times multiple would mean your value, the value of your business, is about $200,000.00.”
The multiples vary by industry and company size. “When you’re looking at a manufacturing company with 20 employees and revenues of $3 million, that may warrant something close to the four times earnings multiple,” Patel says. “We have a database with about 90,000 closed transactions broken down by SIC codes.”
Equally as important, an extensive business appraisal includes market research and a robust discussion of all the factors that have an impact on the appraiser’s decision to come to the best conclusion of market value. It is information that lenders can use to determine if the business is likely to meet debt service payments in the near term and continue to enjoy future growth. Similarly, sellers can glean information to make presentations to prospective buyers.
Whether or not a seller chooses to disclose his company’s appraised value depends upon his negotiating tactics. That is especially the case for middle-sized, privately held companies with strong earnings being bid on by several buyers in a controlled action processes. When suitors know the appraised value, it could limit the upper bid and lower the eventual selling price.
Michael Arrowsmith, managing director for the Tampa, Florida office of National Franchise Sales said that his view is somewhat different since his company re-sells existing franchise units. “Our market might be a little bit different,” he said. “(This is) by far, the busiest year and most successful year we’ve had in the last five.” Most of his buyers are already in the franchise business, do not need seller financing and have the kind of track record that lenders want.
“Typically the folks that we deal with are experienced in the franchise industry,” Arrowsmith said. “So they’re able to get this financing that’s out there for select brands and select type of buyers.” Moreover, he said that sellers are motivated to list and their franchises now because of “Bush tax credits that are going to be expiring at the end of this year.” Sellers also fear that the next president will do away with the low capital gains tax rates and want to benefit from the opportunistic window that may close soon.
When to sell, how to structure a favorable tax-advantaged transaction and preparing an exit plan are integral parts for seller-advantaged closings. Instead, many business owners sell to quickly when they burn out because they want to change their lifestyle. “If you’re thinking about selling your business, you’d better start thinking of it three years earlier,” Arrowsmith says. “Your focus needs to be on building your business, building your sales, putting a strong team in place, managing your business; and don’t take your eye off the ball.”
Rozman, the BoeFly moderator, wrapped up the formal session and orchestrated a question and answer session. He also pointed prospective borrowers to BoeFly’s Fundability App, which estimates how many of BoeFly’s 2,400 lenders might be interested in financing a specific business by plugging in a few salient details.
BoeFly Blogger Jerry Chautin is a former entrepreneur, commercial mortgage banker and business lender. He writes and blogs about business and real estate for several publications and is SBA’s 2006 national “Journalist of the Year.” Jerry is a volunteer business mentor with SCORE, a SBA resource partner offering free business advice. Post your comments and ask questions on this blog or send Jerry an e-mail.