Selling Your Small Business—Part II

By Rudman Winchell Attorney

By: Rudman Winchell Attorney Brent Singer

Show me the money.

Although numerous issues arise when trying to sell a business, in some ways the most important, and often the biggest obstacle, is where is the money coming from for the buyer to buy the business?  In the end, it is all about the money, and without the money, there is no deal.

The answer to “Where is the money coming from?” will drive much of the dynamics of the sales process, as well as determine what will be many of the biggest issues.  The money can come from several places. 

Buyer Already Has The Money

If the buyer is, for example, a much bigger business, the money (cash) might just come from one of the buyer’s own general accounts.  This, naturally, makes things easier, if the buyer, on its own authority, can simply wire, say, $4,000,000.00 into the seller’s account at closing, once all conditions for closing have been met.  Often this is the best scenario for the seller—the only drawback, sometimes, being that if the buyer is rich enough to just write the check, it’s also rich enough to dictate other terms and just walk away if it doesn’t get what it wants.  If the buyer is fair and reasonable, that’s not a problem.  If not, it can be a problem dealing with all of the buyer’s demands.

Buyer Borrows From A Bank

The buyer’s money, or most of the money, can also come from the buyer’s bank.  This happens regularly.  The upside for the seller is that if this happens, the seller gets to walk away with the cash at closing (unlike “seller financing,” described below).  The downside is that this introduces into the deal a third party, who is very important and big, because it has the money.  I cannot emphasize enough how much more formal and sometimes difficult a deal can be when a bank is providing the money (i.e., lending the money to the buyer to buy the business).  This is not because banks are “bad guys,” but because they have definite interests at stake, at well, in maximizing the chances the buyer will be able to pay off the loan, and if not, maximizing the bank’s chances of being able to recover some of its losses by enforcing liens or mortgages taken from the buyer on its new business as security for the loan.

Sometimes, if the buyer is already a very good client of the bank, the bank will take a somewhat more relaxed or flexible posture—but often this is only because the buyer already has so much on deposit with the bank that in comparison, these loans are not so great, and such deposits can serve as collateral in their own right.  Generally, because of increased banking regulation in the last couple of decades, even if “local bankers” desired to undertake somewhat greater risks on behalf of buyer/clients, banking laws may not permit it. 

For example, it is not uncommon for the buyer to have been an employee (often trusted employee) of the business being sold, or otherwise someone on good terms with and very familiar with the seller.  And suppose there is a parcel of real estate involved.  If the buyer were just buying the business with its own money, including the real estate, the buyer might be familiar enough with the property not to worry about potential environmental liabilities or title defects.  The buyer might as a practical matter know that the buyer is assuming very little risk in buying the property.  But that will not impress the bank.

Instead, the bank will look at the real estate as perhaps the most important asset if the buyer defaults and the bank forecloses on the mortgage.  The bank, therefore, will not and reasonably cannot be expected to just “go along with the buyer” and not worry about things.  This means there might have to be environmental surveys undertaken by environmental engineers, or even lawsuits to “quiet title” to the real estate, before the bank will be satisfied and agree to loan money against the new business and its property.

Similarly, although the buyer might be satisfied with the financial statements it has received from the seller, or might not even need any, the bank will want to see them.  The bank may require more formality, or in the end not be satisfied that the business is creditworthy.  Or the bank might require more significant and risky (for the seller) “representations and warranties”(in Part III I will talk about these), than does the buyer. 

The seller should not be bashful early in the process about finding out from the potential buyer where the money is coming from.  Unless the seller is sure that the buyer has the money, the seller should strongly encourage the potential buyer to contact and work with its bank, and bank counsel, as early in the process as possible.  Sometimes a bank will require a signed purchase and sale agreement (“P & S”) before it will deal seriously with a buyer, in which case the P & S will contain a provision that permits the buyer to walk away from the deal if it cannot obtain the necessary financing.  Sometimes, instead, the bank will require a signed “letter of intent” that recites the basic deal points (not binding, as yet), and provides that the seller will deal exclusively with the buyer for a period of time (a binding promise) while the buyer (and the bank) studies the business, tries to line up financing, and the parties see if they can negotiate and binding, definitive P & S. 

Regardless, if and when the bank makes its presence known, I cannot emphasize again how much the seller and buyer need to understand that the bank (or the bank’s attorney) is not some intruder at the party, but rather the most important invited guest.  As documents and deal points are exchanged or refined, it is important to keep the bank in the loop, always.  Again, something that might be just fine with the buyer may not be fine with the bank.  And the bank has the money.  Hence, not uncommonly the final form and substance of key closing documents is determined by the bank.

Buyer Has No Money And Cannot Get A Loan

Seller financing is often the last resort and least satisfactory source of money, at least from the perspective of the seller.  When the deal is thus “seller financed,” the seller does not walk away with cash (or much cash) at closing.  Instead, the seller walks away with a piece of paper, signed by the buyer, promising to pay the seller money in the future.  And who knows what the future will hold.

That being said, seller financing is sometimes a reasonable, effective option.  Often it works out fine, especially depending on the nature of the business and the diligence of the buyer in running the business.  Also, seller financed deals can be some of the easiest to put together because no bank is involved, and the seller can usually dictate most of the terms and conditions.  The drawback, obviously, is if the buyer defaults, the seller’s only remedy, usually, is to basically take over control of the business, again, and run it, to see if the seller can make some money and maybe find a different buyer.  This is because if the buyer had significant other assets available to cover the debt, the buyer probably could have gotten bank financing, or just financed the purchase, itself.  

When considering seller financing, there are some things to consider.  First, how long should the term of the promissory note be?  Should it be a 3 year obligation, or, say, 10 years?  The longer the term, the lower the monthly payments and the less likely (maybe) the buyer will default.  But the longer the term, the longer the seller remains at risk of not getting paid, or of not continuing to get paid.

One thing always to consider is a balloon payment after, say, 3 years.  For example, it might be a $3,000,000.00 note at closing with monthly payments of interest and principal amortized over 7 years, so that after the end of the 3rd year, substantial principal has been paid down, and all remaining principal is due (say, e.g., $2,000,000.00).  After three years of operation, and now only a $2,000,000.00 debt, the buyer might now be able to get a bank loan on good terms, whereas at closing no bank would have lent buyer $3,000,000.00.  That way, after three years, the seller gets paid in full, and the buyer refinances with the bank.  Naturally, though, if the buyer can’t make the balloon payment after 3 years, and still can’t get a bank loan, the seller will have to decide whether to take back the business or refinance the debt by giving the buyer, say, another year to pay a balloon at that time.

Also, if the buyer is a legal entity, rather than an individual, the seller, if there is seller financing, always also get personal, individual guarantees from all of the owners of the buyer, even if such individuals are, candidly, broke.  Not only are such guaranties possible later sources of money, but they provide more leverage, psychologically and legally, if the going gets rough.

Finally, many deals turn out to involve a combination of all three sources of money:  The buyer antes up some of its own money, a bank lends some money, and the seller finances a piece of it as well.  Other sources of money might also include outside private investors—a rich uncle, maybe—or in some instances government programs or venture capitalists.  These raise other issues, beyond the scope of this series.

In Part III we will look at the issue of warranties, representations, and indemnity—often the most hotly contested issues in the P & S.    

[1] In Part I, I discussed some of the most basic, preliminary points about selling a business, namely, “What are you selling,? and what sorts of documents or records will you need.


These materials have been prepared by Rudman Winchell for educational purposes only. They should not be considered legal advice. The transmission of this information to you is not intended to create a lawyer-client relationship. Readers should not act upon this information without seeking professional counsel. You should not send any confidential or private information to Rudman Winchell until a formal attorney-client relationship has been established, in writing.