Today’s segment is going to focus on how Sellers feel about Owner Financing a portion of the sale of their Internet Company. Of course, the obvious thought process when attempting to SELL a business is to get as much money up front to maximize cash at the closing table – this clearly reduces the risk to zero of not receiving the entire purchase price. Business owners are usually weary of taking a promissory note from a buyer because even though they will go through the due diligence process, together, it’s impossible to know how the buyer might perform in the future. And even if it’s a buyer that will likely do well as a website operator, it’s impossible to know how the Internet Sector might change in the coming years. These issues bring trepidation to the thought process of an Owner, and we deal with these trepidations every day, so we thought we would bring up a few points that both Buyers and Sellers of eCommerce and Internet companies should think about.
By far, the vast majority of website purchases are performed via some form of Bank Financing. And very few banks will fund a website acquisition without backing from the Small Business Association (SBA). So, there are various policies that SBA lenders must follow in order to receive backing. And of course, banks also have their own underwriting rules. Most banks will require that the seller of a business underwrite a portion of the sale, so it usually must be a part of the transaction.
As a Seller of an Online Business, when preparing an exit strategy it is best to plan on a portion of the sale of your business to come over time, in the form of a promissory note. It’s important to note that promissory notes between the Buyer and the Seller must take a second security position to the primary bank loan, and usually the bank will prohibit payments on secondary notes for a period of time after the sale. Based on this, when we talk to Sellers about Owner Financing, we generally focus on the following bullet points:
• Owner Financing is usually a way to make the Buyer feel more comfortable with the transaction because both the Buyer and the Seller have skin in the game. If no Owner Financing were included, the Seller would be less likely to help in times of need.
• Owner Financing is a good way for Buyers to minimize the down payment so that the business can pay for as much of the purchase price as possible over time. And by having extra cash on hand, it is easier to deal with hard times where cash flow might be tight.
• Owner Financing is oftentimes a negotiable touch point in transactions and usually will have an effect on the overall purchase price. The Percentage of Owner Financing in a deal can cause a purchase price to fluctuate during negotiations since the Owner is taking on additional risk.
• Owner Financing can sometimes be a good thing from a tax standpoint. It is usually a good idea to talk to a tax professional to identify what, if any, tax-related benefits could potentially arise from owner financing a portion of the purchase price.
There are a number of ways for owners to finance a portion of the sale of their own business, but the most common are promissory notes, earn outs and escrow arrangements.
Promissory Notes are the most common. Negotiated terms are usually focused on the timing of the payback period, the interest rate and other terms generally associated with any business loan. Clearly, the more that is financed via a Promissory Note, and the longer the payback period, the more risk involved. But when a business is difficult to sell, whether due to purchase price constraints or other issues, Owner Financing can sometimes be the difference between a successful sale and an unsuccessful one. If a promissory note is used in the purchase of a business, we recommend that the Seller seek advice of counsel, who will likely advise the Seller to secure the note by filing a UCC-1 financing statement, requesting a personal guarantee from the Buyer, and securing the note against all of the assets of the business, including the domain name, customers, goodwill, etc.
Earn Outs are another form of owner financing, and they can be performance or non-performance based. If performance based, usually certain metrics are agreed to between Buyer and Seller and the business must achieve those metrics in order to be paid. Non-performance based means that the Seller gets paid regardless of sales performance. Earn Outs can be used to boost the purchase price of a business without effecting the 75/25% split requirement of the SBA.
And yet another tool used by buyers and sellers are third party escrow arrangements. These can come in a number of different forms, but generally a portion of the purchase price is placed into escrow and the parties put into writing how the escrow funds are to be distributed, post-sale.
