Deciding how the purchase of a business should be structured is no small task. If you are planning to ask the seller of an accounting practice to help you with some ‘seller financing’ or a ‘seller note’, you’ll want to raise this issue early in the discovery process or when you’re close to preparing to make an offer via a letter of intent (LOI). When it comes to small business sales, a high percentage of deals include some seller financing. Here are some of the most important things you’ll want to think about beforehand.
Amount and Length of a Seller Note
Most sellers, especially ones that are retiring, are usually looking for a large chunk of whatever the purchase price is, as a cash down payment at closing. We regularly see 80% to 90% of the purchase price paid to the seller at closing, with the rest on a 12-month seller note. If you are looking to finance your purchase with a bank loan, conventional or SBA, it is common for the bank to suggest your seller take a note for 10% of the purchase price so they have ‘skin in the game’ so to speak, during the first 12 months to transition clients to you the buyer.
Beyond 12 months most sellers are completely out of the picture (unless you’ve hired them to stay on) and you as the new owner have complete control of the servicing of the clients. Because of this most sellers are not interested in any type of seller note beyond that time frame. Remember that accounting and heavy tax practices are peppered with phone calls and offers from most of the ‘taxes-done-while-you-wait’ franchises offering 1.5X or more times gross revenue, with low or no-money down and long 5-8 year seller notes. Although these terms might work for some firms, if the seller you are talking to had any interest in those types of terms they would have taken them long before you found them.
The simple fact is that interest rates cannot be overlooked. In an era where interest rates have climbed and hopefully peaked, future rates are let’s say – uncertain. That is why it is an important to factor in interest rates to your buying decision for any bank financing and accompanying seller financing. In the event that you find a seller open to seller financing, you’ll need to consider what might be an acceptable interest rate for a seller note, given what your bank will be charging you.
The Debt-Service Coverage Ratio
If you’re using bank financing, they will look at your financial strength as well as that of the target firm you want to acquire. Among other calculations banks will look at DSCR or debt-service coverage ratio. DSCR measures a firm’s available cash flow to pay current debt obligations. The DSCR shows lenders and you, whether your newly acquire firm will have enough income to pay its debts. The ratio is calculated by dividing net operating income by debt service, including principal and interest. Short-term seller notes give you the buyer some extra financial breathing room during the first year of ownership.
There will, of course, be tax implications to the sale to both buyer and seller. Outside of the accounting world we tell buyers that it is only prudent to work well in advance with a tax professional, to understand every tax implication. As an accountant and/or investor, you should have already gained an understanding of how the taxes will work long before a sale takes place. Sellers may also want to talk to an experienced attorney to understand the legal implications of any seller financing.
Just as taxes can throw a curveball into the mix, this fact holds true for additional costs. You’ll want to consider if there are any unsecured creditors that still need to be paid in full. Closing costs can be an issue but are usually rolled into a bank loan if that’s the path you take. Ask your lender for details.
Knowing Your Broker and Lenders That Can Help You
Although business brokers typically are hired by and work for the seller, they can be a good resource for banks that understand accounting practice acquisition loans as well as attorneys that can assist you in this process. If you are not already working with one already, we here at ABA Advisors can refer you to banks & lenders that specialize in these types of loans and can answer your questions on this topic. Feel free to call us at 317-546-7720 to get you started.
Working with a business broker or M&A advisor is a savvy way to address all of these issues well in advance. There are many factors that go into the sale of a business and having an experienced professional by your side is simply invaluable.