Part I of the “All in Family” article series looked at several key considerations for business owners looking to sell to family members. It covered determining company direction, addressing management plans, pricing and more. Once those topics are discussed, an owner must determine the method and financing of the sale.
Stock sale or asset sale
Generally speaking, there are two ways to buy a company. The simplest way is a stock sale. In a stock sale, the owners sell their company stock to the buyers. Once the buyers acquire all the stock, they own the business.
An alternative method is an asset sale. In this scenario, the company sells its assets—tangible and intangible—to the buyers. The buyers often assume all the debt as well. However, the new entity does not inherit any potential and unknown future liabilities.
Both options have legal and tax ramifications. However, I have always preferred asset sales. In an asset sale, unknown liabilities, for example potential future lawsuits, stay with the old corporate shell. Thus, the new generation starts with a clean slate.
This decision is complex. An owner should be sure to get proper legal and tax advice. Depending on their situation, this decision could affect the new generation’s chances of getting financing.
Get the financial house in order
Before looking for financing, an owner must get their company’s financial affairs in order. An owner should ensure their accounting books are correct, keep an eye on receivables and track payables carefully, and make sure all taxes are up to date—especially payroll taxes.
Owners should advise the incoming generation to do the same with their personal finances and taxes. These matters need to be in order before moving forward.
Financing the transaction
If an owner has followed the previously outlined steps, the financing part of the transaction should be relatively straightforward. Most acquisitions have three financing components:
1. Seller financing
Sellers often issue a loan to buyers to help them buy the business. Technically, this type of financing can cover 100 percent of the cost of buying the business. However, it typically covers 20 percent to 40 percent of the cost. The remainder is usually covered through a combination of external financing and buyer’s equity.
Sellers can create any type of loan, as long as it is legal. However, an owner can also use seller financing as a tool to help the next generation. The owner can offer a preferential rate, extended terms and other accommodations.
2. Term loan
The second component of most transactions is a term loan. Transactions of less than $5 million use Small Business Administration-guaranteed loans. Transactions for more than $5 million need to use conventional banks or specialty lenders.
SBA-backed loans provide very attractive rates to small business owners. They are a great product for business acquisitions. These loans have the same underwriting and qualification requirements as normal bank loans. However, the SBA guarantee ensures that they are available to small business owners. Note that SBA loans require that the buyers make an equity investment.
As part of most transactions, buyers invest their funds as equity. Transactions that have an external lender usually have an equity requirement. SBA-backed loans require that buyers invest 10 percent of the transaction value using their own funds. That amount can be lowered to 5 percent if the buyers can get seller financing and if the seller is willing to take a standstill on the seller financing note.
Business sales and transfers are complex transactions. Owners should engage the services of competent legal, tax and financial experts before proceeding.