Will You Need To Carry A Note?
Here is where our company really shines and in many cases makes your life after the sale so stress free. For almost all of the businesses that will price over $500,000, we will have the business pre-qualified BEFORE we go to market. Why is this important? Because we can determine how much a buyer would likely need to put down in order for you to NOT have to carry a note. That is our goal… for you to NOT carry a note. Additionally, knowing the predetermined amount that will be needed to get the deal done is super important for a whole host of other ‘things’ that are super proprietary, all of which will help get your company sold quickly. Give us a call to find out more, as there is a lot more that goes into this.
Keep in mind, not all deals will be “financeable”. If you have had a heavy downturn in the current year or a steady downturn for multiple years in a row, you’re not likely to get a bank to fund the deal. However, in this scenario (and some others), if a bank does agree to carry a loan they may require a huge down payment from the buyer, but if the amount down becomes too high, let’s say it’s 40% or more of the price, it will push buyers out of the purchase. Many buyers will be more inclined to take that large down payment amount (if they have it available) and use it to purchase another business that has stronger (sales and earnings). When a deal gets into this realm (large down payments required) buyers seem to always want to put down the least amount they can to try and get the largest return. Here’s why…
Let’s say you have a deal with a $500,000 sale price and the bank comes back and says they can’t do the deal without 40% down or $200,000. The buyer could take that same $200,000 – as 20% of a larger deal – a business priced at $1,000,000 (20% of $1,000,000 is $200,000) and potentially get a better return on investment. Here’s why…The $1,000,000 business is likely showing earnings of $330,000 (that’s a 3x multiple which would be likely (or possibly more) on earnings over $300k). The business priced at $500,000 is likely making around $190,000 in earnings (about a 2.6x multiple – a lower multiple because the earnings are lower). So for the same $200k down, a buyer could likely take out $120,000 in wages, pay their debt service of around $106,000, and still have $103k left over to do with what they wished. In comparison, with the $500k business at 40% down ($200,000) the buyer would likely take a $120k wage, pay the debt service of $39k a year which would leave only $32k after paying the debt service. That’s only a 15% return on their investment vs. a 52% return on the other, with the same $200,000 down payment! That’s a big difference.
Additionally, larger companies tend to be less “volatile” and their earnings are likely to continue on with less problems vs smaller companies. This is why the multiple used gets smaller with smaller companies due to the “risk assessment”. This same principle applies to Wall Street level firms as well. We present this scenario to simply illustrate the “thinking” that goes on in the industry with many buyers.
To conclude, we know that sellers do NOT want to carry a note if they can avoid it. It’s messy and for a franchise purchase it’s even more complicated. For one thing, after you sell the franchise you can’t just ‘take back’ the business if they defaulted on your note. You would no longer be a franchise owner. You would have to be re-approved by the franchisor, and in some cases, there may be friction between the seller and the franchisor, leading the franchisor to denying you as a franchisee. Ultimately, your remedy would be obtaining your funds strictly through the purchase agreement language, as well as any assets the owner might have personally. As business owners ourselves, and carrying notes personally on multiple transactions, we are aware of most of the pitfalls that occur. If you’d like to explore this more, a phone call is probably best. And don’t forget to ask us about some specific language to insert into the purchase agreement that still gives you some control over the buyer on a monthly basis until your note is paid in full. It’s language that we’ve worked out from serious trial and error that most attorneys overlook.