SBA Update - What's Happening in Congress

On Thursday December 10th, Sens. Landrieu and Snowe introduced S. 2869, the Small Business Job Creation and Access to Capital Act. This new bill contains a series of measures that were separately introduced by Sens. Landrieu and Snowe earlier this year. The Senate Small Business Committee will mark up S. 2869 Thursday, December 17th. Highlights of the legislation include:

• Increase the loan limit on 7(a) loans from $2 million to $5 million.
• Increase the loan limit on 504 loans from $1.5 million to $5.5 million.
• Increase the loan limit on microloans from $35,000 to $50,000.
• Allow the 504 loan program to refinance short-term commercial real estate debt into, long-term, fixed rate loans.
• Extend the authorization to provide 90 percent guarantees on 7(a) loans and fee elimination for borrowers on 7(a) and 504 loans through December 31, 2010.
• Direct the SBA to create a website where small businesses can identify lenders in their communities.
• Increases the maximum guarantee on 7-A loans to $4.5 million.
• Changes the eligibility criteria to (a) a tangible net worth not to exceed $15 million and (b) the average net income after Federal Taxes over the past two full fiscal years is not more than $5,000,000.

The International Business Brokers Association® is the largest international, non-profit association operating exclusively for the benefit of people and firms engaged in the various aspects of a business brokerage and mergers and acquisitions. IBBA® has 1,950 members worldwide, with corporate headquarters in Chicago, Illinois.

Understanding Seller Financing in a Business Sale

It has traditionally been a common practice for the sale of a privately-held small business to include some seller financing as part of the deal structure. Because of the tight credit market and lender efforts to reduce their own risks, that practice has become even more common and may be the key to getting the deal done.

Seller financing can accomplish several goals beneficial to both parties. From a buyer's perspective, most buyers feel there is a risk that the success of a small business is tied to the involvement of the owners. By having the seller finance a part of the purchase price, it can give the buyer confidence in the fact that the sellers believe that the business can thrive without them. From the seller's perspective, seller financing can help a buyer pay more for the business than if the deal were financed only through traditional financing sources.

With that in mind, it is important to remember that the purchase/sale of a business is a two-way street. Just as a buyer will conduct due diligence to determine the viability of the business, become comfortable with its financial and legal matters, and assess the opportunities for growth, a seller should be comfortable with the buyer as well, particularly if the offer includes a loan by the seller. The seller should understand the buyer's business background and qualifications, motivation for buying the business, and financial capacity to purchase and sustain the business.

Business owners who extend financing to a buyer for the purchase of their business often ask, "What happens if the purchaser defaults on the loan?" Should that happen, the seller would be able to exercise whatever rights are defined in the security agreement that is associated with the promissory note. The seller would usually have the right to get the business back, which may not always the best scenario if the business has declined and is not performing well. In addition, if the buyer is using the business' assets to get a bank loan, the seller will have to take a second position behind the bank. A seller should try to negotiate a personal guarantee by the buyer as part of the terms of the promissory note. The seller can also require the new owner to provide periodic reports on the performance of the business as part of the terms of the promissory note.

While it is important for a seller to protect themselves should a default occur, keep in mind that seller financing is often required for a reason, such as lack of bank financing, risks in the business, or to bridge a value gap. In other words, seller financing may be required in order to get the deal done.

Regarding the interest rate to be paid for the seller note, if the seller note is in conjuction with a bank note, it is hard to substantiate a rate much higher than the bank since a buyer is generally utilizing seller financing as a "bridge" mechanism to help the seller attain a higher price.

In the course of due diligence on the buyer, it is acceptable to ask for their credit record, particularly if the buyer is an individual. Personal credit records are available through several outside services, as long as written authorization is given by the individual. There are standardized forms that can be used whereby the buyer grants permission for the seller to obtain credit reports from specific consumer reporting agencies. Many of these credit companies can be queried via the Internet, such as Equifax, Experian, and TransUnion. If a fee is charged to obtain the reports, the buyer can be asked to cover it. The seller may also ask the buyer for a list of financial and business references.

Seller financing can accomplish the goals of, and be beneficial to, both parties as long as each feels confidence in the other.

The Five C's of Credit Analysis for Getting a Loan for Buying a Business

If you are buying a business and plan to obtain financing from a lending institution, these five tips provided by Adeline Rem, Regional Vice President of Celtic Bank, will be helpful in getting your loan approved.

1. Capacity

The capacity of the borrower to repay is the most critical of the five factors. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships -- personal or commercial -- is considered an indicator of future payment performance. Prospective lenders also will want to know about your contingent sources of repayment.

2. Capital

Capital is the money you personally have invested in the business and is an indication of how much you have at risk should the business fail. Prospective lenders and investors will expect you to have contributed from your own assets and to have undertaken personal financial risk to establish the business before asking them to commit any funding.

3. Collateral

Collateral, or guarantees, are additional forms of security you can provide the lender. Giving a lender collateral means that you pledge an asset you own, such as your home, to the lender with the agreement that it will be the repayment source in case you can't repay the loan. A guarantee, on the other hand, is just that -- someone else signs a guarantee document promising to repay the loan if you can't. Some lenders may require such a guarantee in addition to collateral as security for a loan.

4. Conditions

Establish the focus and intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender also will consider the local economic climate and conditions both within your industry and in other industries that could affect your business.

5. Character

Character is the general impression you make on the potential lender or investor. The lender will form a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your educational background and experience in business and in your industry will be reviewed. The quality of your references and the background and experience levels of your employees also will be taken into consideration.

This article was authored by Adeline Rem, Regional Vice President of Celtic Bank, and published here with permission from the author. She can be reached at 512-215-2727.

SBA Loans for Small Business Acquisitions Improving

The Small Business Administration today announced their support of the Federal Reserve Bank of New York and the Treasury Department to improve the TALF Program, which will help unclog the secondary market for asset-backed securities, including SBA 7(a) backed loans which is the vehicle used for small business acquisitions.

“We are pleased that terms for SBA loans are continuing to improve, and TALF is moving into the implementation stage where loans will be made,” said SBA Acting Administrator Darryl K. Hairston. “SBA welcomes the recent announcement from TALF and supports its continued efforts to modify the terms to help unfreeze the secondary market for SBA loans, thus making it easier for our lending partners to make new loans to America’s small
businesses.”

“Three specific changes should be especially helpful to the secondary market for SBA loans. The lower collateral requirements for pools with longer expected lives; the creation of a federal funds-based rate; and the reduction in spreads over the base should all combine to make SBA guarantees a more attractive asset class for investors,” added Acting Administrator Hairston.

The Term Asset-Backed Securities Loan Facilities, or TALF, was announced in November 2008 to inject new life into a secondary market that had virtually ground to a halt in October, making it very difficult for lenders to sell loans they make – including SBA-backed loans – and use the proceeds to make more loans. TALF is intended to help unclog the secondary market for SBA loans by making funds available to investors and brokers to purchase loan pools.

About $4 billion in securities backed by SBA-guaranteed 7(a) loans are bought and sold in the secondary market each year, with the total outstanding amounting to about $15 billion. At present, an estimated $3 billion of that amount is essentially frozen thus hampering the ability of some of SBA’s lending partners to make new SBA-backed loans.

The loans that investors will receive from TALF can be used to purchase these securities from brokers, which would inject much needed liquidity for lenders to be able to make new loans.

Private Equity Groups are Hunting for Business Acquisitions

Private Equity Groups have not been hard-hit by the credit crunch or the stock market decline. They have capital to invest and are looking for business acquisitions.

One of the major market shifts for the acquisition of privately-held companies has been the growth in the number of Private Equity Groups (PEGs) over the last decade, they number in the thousands.

PEGs have become key players in business acquisitions. They offer flexibility as a liquidity source, giving entrepreneurs the ability to take some cash off the table, recapitalize their company or simply sell and move on.

Private equity refers to buyout groups that seek to acquire ongoing, profitable businesses that demonstrate growth potential.

The private equity market had traditionally been restricted to acquiring larger companies. But increased competition for those larger operations, the greater growth potential of smaller firms, and an easier path to exiting the investment of smaller firms in the future have played a role in attracting PEGs to smaller companies.

PEGs are typically organized as limited partnerships controlled and managed by the private equity firm that acts as the general partner. The fund invests in privately-held companies to generate above-market financial returns for investors.

The strategy and focus of these groups vary widely in investment philosophies and transaction structure preferences. Some prefer complete ownership, while others are happy with a majority or minority interest in acquired companies. Some limit themselves geographically while others have a global strategy.

PEGs also tend to have certain things in common. They typically target companies with relatively stable product life cycles and a strategy to overcome foreign competition. They avoid leading-edge technology (this is what venture capitalist want) and have a preference for superior profit margins, a unique business model with a sustainable and defensible market niche and position.

Other traits that appeal to PEGs are strong growth opportunities, a compelling track record, low customer concentrations, and a deep management team. Most prefer a qualified management team that will continue to run the day-to-day operations while the group’s principals closely support them on the Board of Director level.

Private equity buyouts take many forms, including:

Outright Sale - This is common when the owner wants to sell his ownership interest and retire. Either existing management will be elevated to run the company or management will be brought in. A transition period may be required to train replacement management and provide for a smooth transition of key relationships.

Employee Buyout - PEGs can partner with key employees in the acquisition of a company in which they play a key role. Key employees receive a generous equity stake in the conservatively capitalized company while retaining daily operating control.

Family Succession - This type of transaction often involves backing certain members of family management in acquiring ownership from the senior generation. By working with a PEG in a family succession transaction, active family members secure operating control and significant equity ownership, while gaining a financial partner for growth.

Recapitalization - This is an option for an owner who wants to sell a portion of the company for liquidity while retaining equity ownership to participate in the company’s future upside potential. This structure allows the owner to achieve personal liquidity, retain significant operational input and responsibility and gain a financial partner to help capitalize on strategic expansion opportunities.

Growth Capital - Growing a business often strains cash flow and requires significant access to additional working capital. A growth capital investment permits management to focus on running the business without constantly having to be concerned with cash flow matters.

PEGs have become a major force in the acquisition arena. They can also be thought of as strategic acquirers in certain instances, when they own portfolio companies in your industry or a related area that addresses the same customer base. These buyers may be in a position to pay more than an industry or strategic buyer that does not have this financial backing.


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The International Business Brokers Association® is the largest international, non-profit association operating exclusively for the benefit of people and firms engaged in the various aspects of a business brokerage and mergers and acquisitions. IBBA® has 1,950 members worldwide, with corporate headquarters in Chicago, Illinois.

©2008 International Business Brokers Association® (IBBA®) all rights reserved. Permission to reuse any or all of this material should be directed to the IBBA at 888-686-4442 and is restricted to IBBA members.

Buying or Selling a Business During Tough Times

With negative economic news grabbing the headlines in the United States, business owners may think it is not a good time to sell their company. But fortunately for owners looking to sell, that is not necessarily true.
Business sales are still taking place with sellers capturing attractive prices and favorable terms, when the deal is structured properly.

One of the the most important foundations of constructing a successful deal has always been a solid buyer, one that is creditworthy. Whether it is an individual, another company, or a Private Equity Group, qualifying criteria are demonstrated business acumen, significant assets to pledge as collateral, or a committed fund behind them.

With a proven, credible buyer at the negotiating table, lenders are more likely to support the transaction.

In today's environment, some seller financing should be expected to get the deal done. It is not uncommon during a tight economy that sellers must share the risks with the buyer and the lender in order to achieve the highest value.

Therefore, now, more than ever, it is in the seller's best interest to find the right buyer. This has resulted in the advantage going to buyers with a strong balance sheet

In today’s tight lending environment, a seller can still get a strong value for the business, but the seller may need to finance more of the purchase price than before. Regardless of the capital structure or finance considerations, a professionally-crafted and creative deal structure is the key.

Typically, seller financing has been somewhere between five percent and 15 percent. With the current lending climate, seller financing may approach 15 percent to 40 percent amortized over 10 years.

After the buyer has proven themselves in the business and shown that the debt payments will be made, the lender may allow restructuring of the seller’s note. As a result, the seller could receive full payment within three years to five years.

While the economy has put a crunch on available financing, it has not had a dramatic impact on the number of potential buyers. We continue to have strong buyer interest in acquisition opportunities and equity capital is still available. With the right buyer, the right portion of owner financing, and the right structure, deals are still getting done across the U.S.

What are the silver linings in today's market? First, the government has a strong focus on freeing up the credit market and the new administration will continue that effort. And, second, although there have been many high-powered, high-paying jobs eliminated over the past several weeks, we are starting to see an influx of contacts by highly-educated individuals who have money and want to acquire their own business as a result.

The American entrepreneurial spirit is still alive.

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The International Business Brokers Association® is the largest international, non-profit association operating exclusively for the benefit of people and firms engaged in the various aspects of a business brokerage and mergers and acquisitions. IBBA® has 1,950 members worldwide, with corporate headquarters in Chicago, Illinois.

©2008 International Business Brokers Association® (IBBA®) all rights reserved. Permission to reuse any or all of this material should be directed to the IBBA at 888-686-4442 and is restricted to IBBA members.

Credit Crunch and SBA Lending for Small Business Acquisitions

Despite the current credit crunch, well capitalized community banks still have money to lend for business acquisitions. The SBA 7(a) loan program is an excellent way for both bank and borrower to tread through this troubled business environment.

While many large financial institutions are licking their wounds from the mortgage mess and the credit market contraction, community banks who are well capitalized and who traditionally don’t participate in these arenas are still a viable source of funds for small business acquisitions.

Because SBA loans have features that reduce risk for banks, they are a valued tool for banks in this environment. And because they offer lower down payments and longer terms, the resulting lower monthly payments are attractive to borrowers.

The US Small Business Administration (SBA) enables private lenders to make loans that they ordinarily would not be able to make by guaranteeing that a portion of the loan proceeds will be repaid to the lender in the event of a default by the borrower. Among many other uses, the SBA 7(a) lending program is the primary vehicle through which small business acquisitions are financed.

Experienced and well-reputed business brokers / intermediaries will have a list of lending institutions with whom they have worked in the past and who are well-versed in getting deals done.

Buying a business can certainly be an emotional ride. It’s a time to work with deal makers and specialists who will help to minimize the stress and help everyone move forward toward the timely completion of the business sale.

Visit our full SBA Financing Article that outlines the process from start to finish. The SBA requires a "Personal Financial Statement" that is used to determine if applicants meet the criteria to receive an SBA Loan. You can review and download a copy here.

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Some content in this article was provided by, Wendy Horak of Bank of Houston SBA Lending Department. Contact her at 713-600-6626 for more information.

Valuation - The First Step Towards Selling Your Business

"I have a medium sized company which I have owned for about 20 years. We specialize in the manufacture and distribution of chemical products and have built a good business. However, my children aren't involved or interested in the business so I am considering selling it. The problem is that I have no idea how to begin the process."

Since most business owners only sell a company once in their lifetime, it is quite understandable when an owner makes such an inquiry. While the thought of selling their company may seem overwhelming to many business owners, if thought in terms of small steps instead of giant leaps, it is really quite simple.

What is the initial question that comes to mind when you think about selling your business? One might guess that you wonder how much someone would pay for it.

Well, your first thought is the very first step you should take towards the ultimate goal of selling your business. Get a valuation to get an objective price range that you could expect to receive in the marketplace. It's that simple.

Typically, the documents needed to determine the probable price range of a company in the current market are tax returns or profit loss statements for the most recent three to five years, a current year profit loss statement, a current balance sheet, and an equipment list. Again, as you can readily see, the required items for a valuation is not complicated. Several years of financials helps paint a historical picture and current trend of the company. Upward trends are the desired scenario.

Since profits on financial statements and tax returns of privately-held businesses are usually minimized in order to reduce income taxes, the financial statements are restated in a valuation to show the true cash flow of the business.

As part of that process, a professional business broker / intermediary will ask easily-answered questions that will help determine which expenses are discretionary in nature or are not strictly necessary. There will be other expenses that may be non-business related benefits going to the owner and family members, or one-time, non-recurring or unusual expenses that would not be borne by a new owner of the business. These expenses will be part of the true discretionary cash flow that would be enjoyed by a new owner.

This valuation, or Broker's Opinion of Value, is normally provided at no cost. It should clearly outline the details that buyer prospects and their advisors would need and can understand. It should be assessed on the same premises lending institutions use for the purpose of determining if the price makes sense. If a formalized business valuation or appraisal is required, a Restricted Appraisal is one alternative, which is less complicated than a Full Appraisal, and much less costly.

Just as an athlete might get a physical to determine their preparedness for a marathon, you should also measure your Company's fitness for the marketplace. A valuation is an unbiased examination of your company's marketability and helps you pinpoint where your company is in its business cycle. It is the foundation, the meat and bones, on which a business owner can base their readiness to sell.

Other considerations in determining the business value will include competition, regional demand factors, proprietary products or processes, what type of buyer the company would attract, favorable lease terms, advantageous supplier relationships, management's desire to exit or stay with the business, concentration of customers, and many other relevant factors.

Your company's history of earnings represents its financial health and can establish the baseline for the monetary worth of the enterprise. The single most important factor for valuation is how much money the business makes. This figure should be maximized and be shown to be maintainable under new ownership in order to get the best price possible when the time is right. Buyers pay for the past, but buy for the future.

Most owners never take the necessary steps to plan their exit and end up selling because of unexpected events or crisis-driven reasons rather than on their own terms. According to members of the International Business Broker Association, 75% of business owners do not know the market value of their company. This is too large a number considering how painless a task it is to achieve.

The sooner you take the first step in determining the value of your business, the more informed and comfortable you will be in planning your next step.....whether it be deciding the time is right to sell now, or making improvements for a future sale.

Understanding the value and what drives the value of your business is the next stride in the small-step approach.

Indo-American Chamber of Commerce Presents Small Business Success Series

The Indo-American Chamber of Commerce of Greater Houston (IACCGH), as part of their Small Business Success Series, will be hosting a moderated dinner event at Bombay Brasserie Restaurant in Houston, Texas, on June 24, 2008. Tara Energy, headquartered in Houston and one of the largest independent retail electricity providers in Texas, is sponsoring the event.

Frank Stabler, CEO of Certified Business Brokers (CBB), has been invited to serve as a distinguished panelist for the event to answer questions on the following topics:

• How To Sell Your Business
• How To Buy An Existing Business
• How To Finance Your Business
• and other related questions from guests and attendees

Since 1999 the IACCGH has been a powerful advocate and important resource for businesses looking to capitalize on the tremendous opportunities presented through international trade. This organization has made a significant impact on the rich, diverse and prosperous Houston economy.

For more information about this event, call IACCGH at 713-624-7131. RSVP Required.

Buying A Small Business - Does The Purchase Price Make Sense?

When considering the purchase of a business, how do you determine if the price is sound? The following formulas can help quantify that answer.

While this is not meant to be a foolproof analysis, it can help validate the purchase price based on real-life criteria. It takes into account that you:

• need a livable salary
• will have debt payments
• will need working capital at time of purchase
• will need cash for a down payment
• should expect to receive a reasonable return on your cash investment (ROI)
• will want a safety cushion to fall back on

For a simple assessment of a business opportunity, let's assume the following scenario:

• Asking Price for a janitorial company is $500K.
• The janitorial company and the buyer are both qualified for SBA financing.
• Current Federal Prime Rate is 5.25%.
• A SBA loan can be obtained at 7.25% for 10 years.
• Working Capital needed is $25K.
• Seller's Discretionary Earnings is $178K.
• Expected Return on Cash Investment (ROI) is 25%.
• The owner is paying his nephew $20K more than a regular employee could expect to earn.
• The current owner is taking a salary of $60K.

A 20% cash injection as a down payment is a typical SBA requirement, which means $100K in liquid funds is required. Based on a $425K loan ($500K purchase price - $100K down payment + $25K working capital) at the assumed terms and by using an amortization calculator, you would find that the annual loan payment would be $59,880.


Working capital consists of operating expenses such as inventory costs, rent and utility deposits, escrow fees, loan costs, and short-term liabilities. A quick estimate of working capital can be achieved by using the Current Assets less Current Liabilities garnered from the company's balance sheet.

The Table for Seller's Discretionary Earnings delineates the owner's total bottom line benefit as a result of owning the company. This is the total non-business related benefits going to the owner and family members on an annual basis. One-time, non-recurring or unusual expenses are typically things such as a new phone system, website development, outdoor signage or moving expenses. See the Table for other items that are used to arrive at SDE.

Fair market wage is an amount that the owner would pay a hired employee for a particular job. For instance, if the owner has been paying his nephew $40K for a job a new hire could do for $20K, the excess wages of $20K would be added to the benefit column in the SDE Table. As for paying yourself a salary, you can determine what you consider fair wage for what your role would be in the company -- or you can put all of the other numbers into the equation and see what is left for salary. If it adds up to your satisfaction, then so far....so good.

ROI for the purposes of this exercise is calculated by multiplying the cash investment by a reasonable interest rate that should be expected on the investment. This is a subjective percentage and a change in this number can substantially change the result of the analysis.

Investment options, such as putting your money in U.S. Treasury bonds has little risk, therefore only 4.5% interest is received. The stock market option, on the other hand, has a higher risk with a higher average ROI of 11% (source: Ibbotson Associates). Venture Capitalists investing in risky internet start-up companies might look for 45%+ ROI. None of these options, however, puts the investor in the driver's seat -- there is absolutely no control over the performance of the funds in which they invest.

Historical data indicates that a 25% ROI is reasonable for a medium to low risk small business acquisition. The greater the risk of the business, the higher the rate of return should be.

As evidenced by the 25.8 million small business owners across this country (source: US Small Business Administration), there are many people who choose to have complete control over the ultimate success and performance of the money they invest through business ownership.

Let's plug all the numbers into the Final Analysis Table to determine the soundness of the purchase price of the business opportunity at hand. The return on the cash investment was calculated by multiplying $100K (cash down payment) by 25%.

After deducting wages, debt service, and a return on your cash investment from the earnings, the business still generates $33,100 in additional funds to take vacation with the family, or increase marketing efforts for the business. You almost have enough to hire a manager to run the business for you. Now would you buy this business under these circumstances? One might suspect the answer would be, yes!

Of course this is a simplified assessment and not all factors are considered, such as growth potential, equipment condition, and other issues that should be considered when determining risk and working capital that might be needed to keep the company viable and growing.

Buying an Existing Business Beats Starting a Franchise

Last Friday afternoon I was a guest on KSEV Radio AM 700 with host Aubrey Thoede and had the opportunity to discuss a subject that many call-in listeners wanted to learn more about....starting their own franchise. But buying a new franchise is not the best way to go about achieving the "American Dream."

Everyone reads or hears about big corporate mergers and large company acquisitions. However, big corporations aren't the only companies being bought and sold. Profitable, privately-held small businesses are changing hands everyday. These transactions are done behind the scenes and are not reported along with the daily stock market news. These business exchanges fly under the radar of the public at large -- which may be part of the reason that it is not commonly understood that buying an existing small business is the most viable path to being a successful business owner.

If you are considering your options for going into business for yourself, buying an already established profitable business should be the first option on your list and starting a new franchise the last. Here are six slam-dunk reasons why:

(1) The Real Scoop On New Franchise Failure Rates

The failure rate of franchises is greater than most people realize - far greater. Everyone has probably heard the rumor that new franchises only have a 5% failure rate. Well, I was somewhat suspicious of that standard. So, in order to back up my suspicions, I did the research. I was surprised to find that there is very little independent study out there. Most research and reporting about success rates of franchises is sponsored by the franchise companies themselves! So, with that in mind, there is good reason that we only hear about how successful new franchise are. Well, here's the real story....statistics:

• Companies that sell franchises go under at a rate of about 15% a year, meaning in any given five-year period, 75% of franchisors disappear.
• Thirty eight percent (38%) of franchise units fail over a four-year period, vs. only 32% of independent non-franchised startups.
• Franchises make lower profits than independent businesses.
• Many franchisees never make much money. Average profitability is poor, especially after taking into account the purchase price of the franchise.

Some of the reasons for not fully understanding the chances of failure of a new franchise include the fact that many non-performing franchise units are taken back by the franchisor or resold to a fellow local franchisee at less than start-up cost. The franchisor doesn't consider them failed enterprises and they never show up as a "closed" business thereby distorting the real story.

Armed with this knowledge, don’t mistake the information provided to you by the franchisor for a balanced consumer guide. It is a carefully engineered sales pitch. Getting hold of the information you need to make a rational buying decision is difficult, to say the least. So use your common sense and a healthy dose of cynical discretion. Franchise agreements always favor the franchisor. It is very easy to be swept away in the heat of the moment and get into a binding contract that is not in your best long-term interests. And it is very hard to get out of a franchise agreement without taking a big financial loss. Remember, the main purpose of franchising is to make the franchisor wealthy.

Compare the odds of starting a new franchise with buying an already established business. Seventy percent (70%) of companies that have been purchased by new owners are still in business five years later, as reported by business brokers/intermediaries and substantiated in a 2003 SBA Office of Advocacy Study.

(2) No Guarantee Of Succes Despite The Hype

Yes, franchises are a known entity and have proven concepts. When you buy a new franchise, it comes with franchise support such as national marketing campaigns and materials for local campaigns, has established relationships with suppliers, and established methods of operation. Training is provided and is usually substantial. You can obtain SBA financing and some franchise companies provide additional loans to new franchisees...sounds good so far. Many franchise companies will even provide a demographic study to assist with choosing a location for the new business. Population, drive-by traffic, potential customer base and a whole series of factors go into the results of the study that will indicate that "theoretically" the business should do well. Ah, but they can't guarantee your success.

An existing successful enterprise has a mature infrastructure and proven systems that include suppliers, methods of operation, and a trained staff already in place. Financing options include SBA backed loans, conventional lending institutions, sellers notes, and 401K plans to name a few. There is nothing "theoretical" about the company's market presence and location that is already established and proven. The proof? Cash flow and paying customers. As for training, all sellers provide at least two weeks training and assist in the smooth transition to the new owner. They may even stay for a longer period of time with agreed upon compensation and if personal circumstances allow.

(3) High Upfront Cost - Can You Repay The Debt

New locations can take a year or more to build and initial start-up costs of a new franchise can far exceed the cost of buying an already established business. Keep in mind that initial start-up franchise costs touted by the franchisor may not include such things as real estate, staff, payroll taxes, local licenses, advertising, or inventory.

On the other hand, all the expenses incurred by an existing business are known quantities. The bottom line -- when you examine the possibility of purchasing an existing business, expenses are already factored into the non-"theoretical" profits. You do not have to go through the trials and tribulations of trying to get enough customers to make a profit because established customers provide an established cash flow, aka money. With an established cash flow it is just a matter of managing the available cash to achieve your business goals. You do not have the extra pressure of finding enough business to pay the bills or hiring and training a new staff. Security and peace of mind goes a long way! When you buy an existing business, at least you know what you are getting for your money. You will know what kind of loans you can get based on the proven cash flow, if the investment will allow you to achieve the standard of living you expect, and if you will realize a reasonable return on your cash investment.

(4) Fees, Fees, and More Fees

A percentage of monthly gross revenues (yes, before expenses!) will be levied as royalty fees (forever!) for the privilege of using the franchise trademarked name and procedures -- which cuts into your profit potential. Other fees you will have to pay include a franchise fee, training fees -- and, in some instances -- a monthly fee for marketing materials and ongoing support. If you are planning future growth and expansion, you will be paying additional fees for licensing the rights for each additional market area.

When you acquire an existing company, the only required fees you pay are taxes. There may be licenses associated with certain types of firms or other regulatory requirements based on the industry. Yes, the debt will have to be paid, but there's an end in site -- a loan has a definite pay-off date. Growth potential of an independently-owned enterprise is only as limited as the market for its product or service and the financial capacity of the owner(s). You are not tied to some radius within which you are allowed to expand.

(5) No Entrepreneurial Freedom

Do you have an innovative entrepreneurial spirit? Do you dislike being told what to do? Do you want freedom with your marketing plan? If so, owning a franchise is not for you. Franchise contracts have very explicit standards, allowing little or no alterations or additions to the brand, stifling any creativity on the part of the franchisee. You must use their system and follow their rules. Some franchise contracts dictate how much to pay your employees and stipulate that you must buy supplies only from their approved list of suppliers, possibly at higher costs than you could find from other vendors. The reputation of your franchise is only as good as that of the franchise company, so any difficulties that the franchise company encounters will have a direct impact on you.

There are enormous growth opportunities with owning a non-franchised, independent company. You can acquire additional businesses, open up new locations, try new marketing campaigns, and add new products or services just to name a few. The fact that you can raise your prices whenever you deem necessary may seem like a luxury in comparison to the opposing reality when you own a franchise.

(6) When It Comes Time To Sell

There can be very restrictive terms if and when you decide to sell a franchise. For example, the buyer will be required to pay a transfer of ownership fee, pay for training, and must be approved by the franchisor.

If you own an independent business, and grow it, you can sell it for vastly more than you paid for it...which makes good investment sense. This is not the case for most franchises because of poor profitability and growth potential.

In Summary

There are some great franchises out there with solid business models but may have frigid rules and ongoing fees that can bog you down. Franchising has been around for a long time and will continue as a viable choice. But don't start a new one, buy an existing franchise, a resale - one that is already up and running successfully. Even though the disadvantages noted above will still apply, at least you will be able to review its sales history so you have some idea of whether it is a money-maker or a lemon.

Buying an existing independent business with all the ingredients for success already in place is a safe investment and a platform from which to grow and launch new ideas. By far a much more flexible and less risky avenue to successful business ownership. No matter which road you take, however, there are no guarantees. You still need to be a sharp businessperson to make it work.

You Decide

The articles below and our own experience for the past 32 years of selling businesses are the sources from which I derived my conclusions.

Hidden Risks of Franchises
Safer to Buy A Franchise? - Think Again
Franchise This

Secrets and Snags to Franchising Success
2003 SBA Office of Advocacy Study

Buying A Small Business - Get Prequalified For Financing

Get Reviewed and Prequalified For Financing So You Can Leverage Your Business Purchase.

Getting prequalified for financing by lenders is very important for two specific reasons.

1) 90% of all small businesses sold have some form of financing involved.

2) One of the biggest reasons that deals falls through is because the buyer could not obtain financing.

While some sellers are willing to provide partial financing to a qualified buyer, they would much rather the buyer be able to get third party financing so they can receive their cash up front at closing. Wouldn't you? The seller takes a considerable risk on a buyer he doesn't know too well and can only hope that the buyer will be successful in running the operation.

The usual cash injection (down payment) required by SBA and other lenders in the purchase of a small business is generally around 20% to 30% and the rest is financed. This, of course, is based on your personal financial standing and background. You will need to submit personal financial information and a work resume.

By having a lender review your financeability and background upfront, the lender can then give you valuable Intel on the types of businesses they would take into consideration for financing based on your skill sets and what they would deem to be transferable to different types of businesses or industries. Not only can you narrow the scope of the types of business you research, you would also know exactly what price range to target.

All of this adds up to the serious, prepared, perfect buyer! A rare species in the land of business brokerage. You'd get the red carpet treatment for sure by business brokers and sellers alike.

Keep in mind that the business you choose must also be financeable. The business must pass the lenders test. For instance, the company's financials must be reviewed by the lender so they can determine if the business can produce the income required for you to make a living after making payments on the loan that they will be providing.

The point to be made here is that you, as a person looking for the "perfect" business to buy, will be ready to pull the trigger when it appears. There are more buyers than sellers in today's business transfer marketplace. You will have an advantage, you will be a step ahead of the rest of the crowd.

Sell Your Business Faster - Prequalify it for Bank Financing

Business Owners Should Prequalify Their Business For Potential Buyers Before Putting It On the Market.

Whenever we advise our business-owner clients this, they look at us sideways wondering if we have lost our minds! They usually reply, "isn't it the buyers responsibility to get prequalified and get financing for the purchase of my business?" Nothing could be further from the truth.

It makes good sense for business owners to have their business financial records, tax returns, deal structure, and price reviewed by lending institutions before marketing the business to prospective buyers for several reasons.

1. Based on the financials and tax returns from the previous three years you need to know if your business is eligible for potential buyers to get a loan to buy your business. If you know that your business is not eligible for financing, then you know that the deal structure for selling your business will be very different without bank financing involved.

2. You also won't waste time with buyers who say they can get financing when you already know this cannot be achieved. Most buyers usually scramble at the last minute to get financing and will be further hindered by lenders who won't approve a loan for your business - wasting your time and theirs.

3. You need to know how you should structure your deal correctly. This will bring the right type of buyers to the table who can complete the transaction with minimal complications.

4. If the business is prequalified for bank financing, not only will you get more interest from the right prospective buyers because of your good financial records, but you will have saved the buyer time and effort in securing financing for the acquisition. Time is a deal killer. So any homework done upfront will pay off at this critical stage of the sale process.

5. Furthermore, a business eligible for financing will usually get a higher price and in many instance get all cash instead of having to take back a note and finance it yourself!

6. Lenders who are willing to finance a business will also give advice on what types of buyers would be approved for financing for your type and potential deal structure. Some lenders will issue a letter of prequalification that can be presented to qualified potential buyers!

7. If you know that you have financing lined up for potential buyers, you can better control the deal knowing that you don’t have to rely on the buyers to go out and search for financing - keeping you waiting as they hunt for a loan and other would-be potential business buyers move on to other deals.

8. In the interest of saving time, a good idea is to encourage buyers to utilize the financing institution that has already reviewed the financials and prequalified the business. However, keep in mind that just because your business has passed the test for financing doesn't mean the potential buyer automatically gets a loan. The buyer, too, must be financeable and have the background required to obtain the loan for the business.

What is usually required to get your business prequalified for financing? Usually 30 minutes of phone time answering questions about the business. The recent 3 years of the company's tax returns. The recent 3 years of business financials -- profit and loss statement, balance sheet, and interim financials for the current calendar or fiscal year.

We have relationships with many SBA Banks and other lending establishments that vary in their criteria and preferences in the types of businesses they finance. It is our standard procedure to perform this prequalification exercise with our clients early in the selling process to achieve our client's goal -- the best possible price in the shortest time-frame possible.

Small Business Loans Hit Record Breaking Levels in 2007

The U.S. Small Business Administration posted record-breaking loan numbers again in FY 2007, expanding access to capital to thousands of entrepreneurs across America and setting records for both the combined number and dollar volume of loans, according to their News Release today.

SBA approved 110,275 loans totaling more than $20.6 billion under its two primary small business loan programs during the 12 months ending on Sept.30 2007, compared with 107,233 loans worth $20.25 billion in 2006. With the strong results in 2007, the combined outstanding loan balances in the 7(a) and 504 loan programs increased 6.5 percent to $66.7 billion. The total does not include an additional $2.65 billion in venture capital funding provided by SBA-licensed Small Business Investment Companies to more than 2,000 small businesses.

The SBA plays an increasingly vital role in enabling small businesses across the country to get the capital they need to buy and grow their businesses, create jobs and build their communities. Although SBA does not make direct loans to small businesses, the agency's use of its guaranty authority enables commercial lenders and Certified Development Companies to make loans to small businesses they otherwise would not have made. Both primary loan programs combined set records this year. The 7(a) loan guaranty program - which can be used for nearly any legitimate business purpose including business acquisitions, debt refinance, business expansions, business startups, equipment and working capital - increased the number of loans from 97,290 in FY 2006 to 99,607 loans in FY 2007. The Certified Development Company - or 504 - program, for the purchase of real estate and fixed assets, provided 10,668 loans worth $6.31 billion, up from the 9,943 loans worth $5.73 billion in FY 2006.

The SBA's loan programs have been setting records for six consecutive years, and have more than doubled since fiscal 2000, from 48,313 to 110,275. During this period, SBA has approved more than 555,000 loans worth more than $107 billion to American small businesses, more than in the previous 10 years combined. Over this time, the agency's total small business loan portfolio has grown to $66.7 billion, compared to $45.9billion at the end of FY 2002 and $62.6 billion a year ago.

For more information on how to get an SBA loan, visit http://www.sba.gov/.

To Build, To Franchise, or to Buy an Existing Business......That is the Question

Should you be the architect of a new business and start from scratch, buy a new franchise, or buy an established existing business?

Every year, thousands of people consider going into business for themselves and these are the three routes to get there. Each course has advantages and disadvantages that one should consider.

Starting a business from scratch.

Starting your own new venture can be very rewarding but needs to have a unique product, technology or service, and a planned operating procedure. One would need to complete a thorough evaluation of the marketplace, competition, availability of employees, suppliers, marketing collateral would need to be designed and printed -- to name a few. An in-depth Business Plan would need to be formulated. If you start your own business, you will not be paying for Goodwill, Bluesky, Royalty Fees or Franchise Fees. You could, perhaps, even start from your home with no employees and greatly reduce the initial capital requirement. With modern technology today a one-person show can seem like a large operating enterprise.

However, you will need to support yourself (and family) from personal savings. There may be months or years before profits are sufficient to provide the level of income needed. Mistakes will be made along the way and new approaches will need to be taken as the business takes shape. Obtaining financing may be very difficult as there is no track record and no customers. For quite some time the general belief and "rule of thumb" has been that 95% of new business start ups fail within the first five years. After doing some research, the most recent study on the subject that I was able to find was published in 2002 in a report by Brian Headd, an Economist with the SBA Office of Advocacy. Headd cited that a more accurate assessment of new business start ups is a 60% failure rate within five years based on the premises he used. Here is the 11-page report -- Redefining Business Success: Distinguishing Between Closure and Failure.

This is a far cry from the previous long-held belief that 50% of businesses fail in the first year and 95% fail within five years (Patricia Schaefer, in The Seven Pitfalls of Business Failure and How to Avoid Them).

Buying a New Franchise

Franchises are a known entity and have proven concepts. When you buy a new franchise, it comes with franchiser support such as national marketing campaigns and materials for local campaigns, has established relationships with suppliers, and established methods of operation. Training is provided by franchisers and is usually substantial, and some franchisers provide loans. With a new franchise, a good Master Franchiser will do a demographic study to assist with choosing a location for the new business. Population, drive-by traffic, potential customer base and a whole series of factors go into the results of the study that will indicate that "theoretically” the business should do well but they can't guarantee your success.

New locations can take a year or more to build and initial start-up costs of a new franchise can exceed the cost of non-franchised business start-ups or buying an already established business. You will have to pay part of your monthly gross (yes, before expenses) as royalty fees (forever), reducing your profit potential. You will also have to pay a franchise fee and, in some instances, a monthly fee for marketing support. Franchise contracts have very explicit standards, allowing little or no alterations or additions to the brand, stifling any creativity on the part of the franchisee. You must use their system and follow their rules. Some franchise contracts stipulate that franchisees must buy supplies only from an approved list of suppliers, possibly at a higher cost. The reputation of your franchise is only as good as that of the franchiser, so any difficulties that the franchiser encounters will have a direct impact on you.

There’s always risk in starting any new business and a new franchise is no exception. Everyone has heard that new franchises are safer and less risky than non-franchised start-ups and only have a 5% failure rate. Well, I was somewhat suspicious of that standard. So, in order to back up my suspicions, I did the research. There really is very little independent research out there. But what I discovered was not surprising. Since franchisers sponsor most research about franchise success rates, it is important that you ascertain the sponsorship of the information you read. Some of the reasons for not fully understanding the chances of failure in a new franchise include the fact that many are taken back by the franchiser, taken over by a third party by purchasing the assets, resold to a fellow local franchisee, or recapitalized by banks using the assets as collateral. They fall under the radar of failed enterprises. Due diligence is very important before embarking on any new venture. You may want to read the the findings of these five studies that disagree with the assertion of only a 5% failure rate for new franchise start-ups.

Hidden Risks of Franchises
Franchise This
The Failure Interview with author of "Franchising Dreams"
The Truth About Franchising
MIT Sloan Management Review

Buying an Existing Business

Buying an established business may be a more efficient way to business ownership. Here's a list of the advantages of buying an existing business:

aCash Flow
aGoodwill and Reputation
aA Historical financial track record
aEstablished customer / client base
aEstablished suppliers & vendors
aFurniture, Office Machines & Communication Equipment are in place
aExperienced Employees
aRelationships with professional advisers, insurance companies, advertisers
aLocation has already been market tested & proven
aPolicies and procedures are in place
aPricing and competition are a known quantity
aGrowth Potential
aBank Finance Options

The advantages of buying an existing business generally outweigh the disadvantages. Existing businesses can normally obtain financing from financial institutions because they have an established history, assets, and a proven idea. The seller will quite often provide training and a portion of the financing in the form of a loan. Seller financing is beneficial to both buyer and the seller. SBA Financing is also a strong possibility provided the business has good financial records.

Business brokers report that seven out of ten businesses they sell are still in business five years later.

In the long run, buying an existing business is often less expensive than building a new franchised location or launching a start-up. Even if you pay a premium price for an existing business, at least you know what you are getting for your investment if you investigate it properly. You will have far more flexibility when negotiating the purchase of an existing business versus the other options. Everything is negotiable. However, keep in mind that the terms must be beneficial to both the buyer and the seller in order to get the deal done.

In summary, the first two options have higher risks and no proven track record in the new location you choose. In a new business start-up, however, if your idea is a winner, the personal satisfaction and monetary rewards may be worth the gamble. Inc Magazine reported in October 2002 that 14 percent of Inc. magazine's 500 fastest-growing companies in the United States started with less than $1,000.

On the franchising side, there are some great franchises out there but may have frigid rules and ongoing fees that can bog you down. Finding an existing business with all the ingredients for success already in place is a safe investment and a platform from which to grow and launch new ideas. By far a much more flexible and less risky avenue to successful business ownership. No matter which road you take, there are no guarantees. You still need to be a sharp businessperson to make it work.

I have been fortunate to experience two of these types of business ownership. First, turning a vision into a new business venture and nurturing its growth until its sale 15 years later. And, second, purchasing an outstanding existing enterprise that fulfills the entrepreneurial spirit almost as much as the former. Find out if you got what it takes to take the leap to business ownership. Take this 25-question entrepreneurial test and read my short post on some of the Key Characteristics of Successful Business Owners.

Buying a Business Using Retirement Funds - An Example

Put your money to work! Invest it in your own business and let your money work for you! You can use cash from your 401(k) or IRA account to purchase a business without incurring early distribution penalties, with no taxes, no loan repayment, and no hassle.

For example, a Texas resident using $100,000 from a qualified retirement fund can keep the extra 31% that would have been paid in taxes, leaving an additional $31,000 to fund the new business by adopting a transfer trust plan versus withdrawing the funds outright.

With the adoption of a pension transfer trust, you are allowed to convert 401(k) and IRA funds into privately-held stock in your new business. Pension and tax advisors can provide all the specific components necessary to make sure the transaction is in compliance with all applicable IRS Code Sections, ERISA Law, and Department of Labor Letter Rulings.
For more complete information on using qualified retirement funds to purchase a business, you may wish to read this article, Retirement Funds Can Finance A Business Acquisition, and visit websites such as these:

DRDA

Guidant Financial Group

Pension Transfer Advisors

BeneTrends, Inc.

The purpose of this article is to alert prospective buyers of alternatives for financing the purchasing of a business and not to provide tax advice. Contact proper legal or tax professionals for more information on this subject.

The 1031 Exchange -- Sell Business Property Now, Pay Tax Later

A growing number of investors are selling properties and paying taxes later through a deal structure called a 1031 exchange.

Section 1031 of the U.S. Tax Code permits a seller of commercial properties to defer the capital gains obligation if it identifies a replacement property within 45 days of closing the sale. The seller must then close on its new purchase within 180 days of the first closing.

In a typical transaction, the property owner is taxed on any gain realized from the sale. However, through a Section 1031 Exchange, the tax on the gain is deferred until some future date. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a business owner who has outgrown a company-owned building, for example, can defer the tax liability as long as the proceeds are used to buy another building of equal or greater value within a specified period of time.

The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer's investment is still the same, only the form has changed. Therefore, it would be unfair to force the taxpayer to pay tax on a "paper" gain.

The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

Key factors to consider for a 1031 Exchange.

1. Investment Intent

Both the Relinquished Property and the Replacement Property must be held for investment or productive use in a trade or business. Personal residences do not qualify. Although there is no specific holding period to establish investment intent, taxpayers who hold their Relinquished Property for two years generally satisfy the requisite intent for a 1031 Exchange. A holding period of over a year has commonly been accepted but may be subject to review by the IRS.

2. Deadlines

Replacement Property(ies) must be identified within 45 days of the sale of the Relinquished Property and must be purchased within 180 days of the sale of the Relinquished Property.

3. Rules of Identification

The Three Property Rule. The taxpayer may identify up to three properties without regard to their value; or The 200% Rule. The taxpayer may identify more then three properties, provided their combined fair market value does not exceed 200% of value of the property sold; or The 95% Rule. The taxpayer may identify any number of properties, without regard to their value, provided the Exchanger acquires 95% of the fair market value of those properties.

4. Equal or Greater

The taxpayer must buy Replacement Property(ies) of equal or greater value to the property sold in order to defer the applicable capital gains tax, or pay tax on the difference. The taxpayer must use all the cash proceeds from the sale of the purchase in order to completely defer the applicable capital gains tax, or be taxed on the funds withheld.

5. Common Ownership

The party selling the Relinquished Property must be the same party purchasing the Replacement Property or a disregarded entity with respect to the party (such as an LLC or a trust, where a single taxpayer holds 100% of the beneficial interests in that entity). Spouses can be added or removed in community property states.

6. Like Kind

The Replacement Property must be "Like Kind" to the Relinquished Property. Any type of real property is like kind to other real property. Personal Residence. Taxpayers can exchange business or investment property, but not their personal residence(s). Vacation Homes. Vacation Homes treated as a personal residence are generally not eligible for 1031 treatment. Investment property listed on Schedule E is generally eligible for 1031 treatment. Condo Conversion. Recent rulings point to the acceptance of exchanging units on a condo conversion, provided the property was held for investments for a sufficient period of time before the taxpayer even contemplated the conversion. Contract Exchanges. Recent rulings point to the acceptance of exchanging contracts, provided all other 1031 requirements, such as holding period and investment intent, are met. Contracts to purchase Real Estate may be exchange for another contract or other existing real property.

7. Qualified Intermediary

To qualify for sale harbor tax deferral, sale proceeds must be held by a Qualified Intermediary between the sale of the Relinquished Property and the purchase of the Replacement Property. A Qualified Intermediary must remain completely independent and cannot have been the taxpayer’s agent in the past 2 years. A CPA, attorney, or other agent cannot act as a Qualified Intermediary for their clients. More information can be found on the FEA website.

Buying a Business: How are Payables and Receivables Handled in the Sale?

What is a common practice for dealing with accounts payable and receivable when purchasing a business?

In most small business transfer transactions the seller will retain the cash and receivables. They will pay off the bills and other outstanding payables and deliver the business "free and clear" to the buyer.

In larger purchases, the buyer should consider acquiring the receivables to provide themselves with immediate working capital. Ample working capital is of utmost importance for successfully running the business after the acquisition. As an added benefit, acquiring the receivables allows the buyer to begin dealing directly with his most important relationships - his customers.

Assuming the payables is also something to consider -- for the following reasons.

1) By assuming the responsibility for the payables, you immediately begin forming your own relationship with another key element of the company -- the suppliers, vendors, and other service providers. It puts you, the new owner, in control of dealing with these important contacts instead of the former owner.

2) The purchase price you pay the owner is reduced by the amount of accounts payable that you assume. Then you, as the new owner, pay the invoices as they become due. Not only would you keep more money in your pocket at closing -- you would essentially have 30 to 60 days of interest free financing for the payables.

3) As the receivables start coming in, you will be able to use that capital to pay the invoices as they come due.

Who Would Be the Buyer of Your Small Business? Part 1

The Individual Buyer Category represents the largest number of prospective buyers for small to midsize privately-held businesses.

Understanding who the buyers are and their acquisition criteria will enable business owners to be better prepared when the time comes to sell. The individual buyer category encompasses a variety of buyer types that include wealthy individuals, corporate executives, engineers and salespeople working for large firms, and immigrants entrepreneurs who have recently moved to the US. There are two other buyer categories that will be discussed in a future post: Financial Buyers (sometimes called investment buyers) and Synergistic buyers. Each buyer category differs in their purpose for making an acquisition and the types of businesses they target.

Wealthy Individuals often are people who have taken early retirement from corporate America and after a brief period of being nonproductive decide to get into their own business. They tend to acquire midsize companies grossing in excess of $2 million.
Corporate Executives, Engineers and Salespeople make up a large portion of those who buy small to midsize businesses. They are often driven to buy their own business due to events in their corporate life such as being asked to move to another city, loss of their job due to corporate mergers or downsizing, being passed over for promotion or fed up with corporate bureaucracy. They tend to buy businesses that gross under $2 million.

Foreign Buyers make up 30% to 40% of the buyers for small to midsize businesses and as much as 90% for specific type businesses such as convenience stores, dry cleaners and liquor stores. They are people who have moved to the US within the past few years. They usually work for family members or friends for a few years until they can better understand the American way of life. They often have substantial equity funds due to having sold their holdings in their country of origin and/or they are often able to borrow money from friends and relatives here in the US. Due to language barriers and an unfamiliarity with marketing techniques, they tend to buy businesses that do not require significant outside sales efforts and where the customers come to the business based on convenience rather than promotional activities.

The majority of the individual buyers have little or no experience in operating the type of businesses they buy. The fact is, if individuals have a lot of experience in a specific business, they will tend to start a business rather than buy one. The number of entrepreneurs who start their own business are ten times greater than those who buy existing companies. Conversely, those people who start their own business are far more likely to fail or go out of business than those who have purchased an existing profitable business. Business brokers (business intermediaries) report that seven out of ten businesses they sell are still in business five years later.

While on the surface it would appear that someone with a lot of experience in a specific business would be the best buyer; however, entrepreneurs who enjoy starting and growing an existing business have a start-it-from-scratch mentality. They don't want to pay for something that they think they already know or can do themselves.

Sources of equity and debt capital for individual buyers come from their own equity funds, family members, financial institutions and seller financing. Buyer equity funds usually represent 30% to 50% of the transaction price. The equity portion of the acquisition price must be liquid and available to the buyer unencumbered by debt. Mezzanine financing is not normally available to individual buyers.

Long-term financing is usually arranged through banks and mortgage companies usually in the form of the Small Business Administration's 7A loan guarantee program. These loans are typically secured by the assets being acquired and the personal guarantee of the borrower. Owner financing is considered by the SBA as equity funds. For a target business to qualify for a buyer being able to obtain a SBA guaranteed loan to finance the tangible and intangible assets of a business, it must have been in business for at least three years and be able to provide three years of tax returns showing sufficient profits to repay the buyers loan and provide the buyer with a livable salary. Adjustments to the reported earnings are allowed for provable expenses that are either non-reoccurring or personal in nature; however, no consideration is given for unreported income. SBA financing may be available for businesses under three years old; however, these transactions are treated as start up businesses and must be fully secured by tangible assets. No portion of goodwill or intangible value will be financed.

A significant portion of transactions involving small to midsize target firms are seller financed. This is usually due to the target company's poor financial record keeping or when the business has been in business for less than three years. Transactions properly structured are usually successful. In fact, after a seller-financed note has matured for six months to one year, there are several national companies who buy owner financed notes. Typical owner financing includes a reasonable selling price, a down payment of 30% to 45% and a payout of 5 to 7 years, with interest at 10%. The note is typically secured by the assets of the business being acquired and the personal guarantee of the buyer. A lien showing the note security is filed with the Secretary of State or required public records. Furthermore, the terms of the note should allow for the note holder to invoke rapid foreclosure proceeding in the event of default.

Acquisition Criteria of the Individual Buyer:

Target companies typically have gross revenues between $200,000 to $3 million. Businesses with gross revenue under $200,000 typically do not provide sufficient net earnings to attract buyers. Businesses with gross revenue in excess of $3 million become difficult for individuals to obtain the necessary financing and to compete with other categories of buyers seeking the larger businesses.

Individual Buyers tend to seek businesses that provide products and/or services that are easy to learn without long periods of training and high costs of entry. Many retail, wholesale, distribution, and service businesses meet this criteria. Businesses requiring professional licensing are usually limited to buyers who either have the license or can get one without incurring major costs or time delays.

Most individual buyers seek businesses that have current earnings at least similar to their most recent salaries, and upside potential for earnings growth. Buyers look for businesses that have good growth potential, but they are not willing to pay a price based on future potential.

While financial results is important, other lifestyle considerations can be equally important. Issues such as being able to control one's destiny rather than letting someone else do it for them; building equity for the future rather than working at a limited future job that can end at someone else's decision; and being able to choose when and where you go to work.

Location of the business in proximity to the buyer's home is often a significant consideration. The business must have "curb appeal." The condition and appearance of the equipment and facilities must be appealing or at least not unappealing. A little paint and attention to cleanliness goes a long way towards making a business attractive.

Businesses with full-time employees give buyers confidence that the business has continuity and stability. Having employees who can run the daily operations is more appealing than those businesses that are highly reliant on the owner to make daily operating decisions or have personal relationships with the company's customers.

Businesses that have verifiable and current financial records enable a buyer to quickly do their due diligence and obtain sources of financing. While allowances can be made for non-recurring and personal expenses that impact the bottom line, no allowances are made for income missing from the top line.

While buyers may not always know the latest techniques for valuing businesses, they are capable of determining if the business makes sufficient earnings to earn a livable salary, pay the new debt service and provide a reasonable return on their investment. Ultimately, these factors are the test to see if the price and terms of any deal are reasonable.

Selling a business can be a traumatic and frustrating experience or it can be a financially rewarding experience providing peace of mind knowing that the business will continue on with job security for its employees and a continuing source of products and services for its customers. Owning a business is part of the American dream. Cashing out can be the continuation of that dream or a nightmare depending upon how the transaction is handled.

Choosing an experienced business broker to guide you through the complicated process of a business sale can insure that the business is priced right, packaged to put the best foot forward and presented to the right buyers in a confidential and professional manner. The costs of the business intermediary's services are more than offset by their ability to prequalify the maximum number of prospective buyers, to obtain a higher price due to proper valuation, and to successfully complete the transaction in a more timely, confidential manner. When buyers see that a business owner is trying to sell their own business, the buyer will reduce the seller's asking price by at least the amount of what would have been a brokers fee. So if the seller ends up accepting the lower price, what did he save? He had to do all the work normally done by the broker, most likely not as well, yet did not get paid for it.

Small Business Owners: Prequalify Your Business for a SBA Loan Early in the Selling Process

SBA Prequalified Businesses for Sale in the Marketplace Sell Faster

The normal train of thought for most people is that it is only the buyer's responsibility to get prequalified and get financing for the purchase of a business. Yes, the buyer must be able to qualify for a loan. However, the business must be eligible as well. No banking institution will approve a loan for a business that does not provide the cash flow needed to support the payments. Therefore, it is beneficial to the business owner to prequalify the business beforehand.

So......why does is make good sense for business owners to have their financial data reviewed by a bank for SBA Loan prequalifcation purposes? Primarily, because it will result in a more speedy sale! Based on your financials and tax returns from the previous three years, you need to know if potential buyers would be eligible to get a loan to buy your business.

Here are the benefits of prequalifying a business for a SBA Loan.

If you find that your business is NOT eligible for SBA financing, then you know that the deal structure for selling your business will be very different without SBA financing involved. For instance, you would require buyer prospects with more money for a down payment or other financial resources, and/or you would need to provide substantial seller financing to the buyer to get the deal done. An all cash deal without some kind of loan involved is rare.

You will be able to search for certain types of prospective buyers -- buyers with the financial profile needed to purchase your business. This will bring the right buyers to the table who can complete the transaction with minimal complications. This will facilitate a faster closing process.

SBA prequalified businesses get more attention in the businesses-for-sale marketplace because it saves potential buyers a lot of effort and time to secure financing. More importantly, however, they know the business is financially sound. The more interest generated in your business, the better the chances for a quicker sale.

If your business is eligible for SBA financing, it will usually get a higher price.....especially if you provide a small amount of additional financing to the buyer. It makes the buyer feel more secure about purchasing your business knowing that you have enough confidence in the performance of the business to provide a loan. Or, based on the buyer's financial capabilities, you may get all cash instead of having to provide any portion of the financing yourself.

When your business is prequalified for financing, you will also get advice on what types of buyers would be approved for financing for your type of business, potential terms, and deal structure. You will also get a Letter of Prequalification you can present to qualified potential buyers.

Prequalified financing helps you get better control of the deal. A good idea is to encourage the buyer to utilize the financing that you have already secured so you will not be kept waiting while they hunt elsewhere. The longer you have to wait the more chance you have to lose other good buyer prospects if the deal falls through.

What is usually required to get your business prequalified?

• Usually less than an hour of phone time answering questions about your business
• The recent three years of your companies tax returns
• The recent three years of your companies financials such as profit & loss statement and balance sheet
• Interim financials for the current calendar or fiscal year.

A business broker will help you get this done early in the selling process.

Types of Financing Available to Buy a Business

Use this Loan Calculator to calculate your monthly payment.

Seller Financing

Read about the issues surrounding a Business Owner's decision to provide financing to an individual who is buying the business in our Seller Financing post.

Retirement Funds

Read how you can access your retirement account without tax penalties to buy a business in our 401K Financing post.

SBA Loans

For information about SBA Financing and the amount required as down payment to purchase a business, read this detailed overview about SBA Financing from a Bank's perspective about The Process From Start to Finish.

Home Equity Loans

Home equity loans in Texas have no legal restrictions regarding how you use your loan proceeds. Therefore, this is an option for financing the purchase of a business. The State of Texas Office of Consumer Credit Commissioner regulates the credit industry and educates consumers and creditors. You can find complete information about Home Equity Loans in Texas here.

Conventional Commercial Bank Loans

Those seeking conventional bank loans will have more success if they have a large net worth, liquid assets, or a reliable source of income. Unsecured loans are also easier to come by if the buyer is already a favored customer or one qualifying for the SBA loan program.

Specific Uses of Commercial Bank Loans

To Finance Working Capital. Financing working capital is the primary area of lending done by commercial banks. This type of loan is granted to finance current assets such as accounts receivable and inventory and generally falls into two loan categories: the short-term demand note and the line of credit.

A Demand Note finances temporary working capital needs caused by fluctuations in accounts receivable and inventory.

A line of credit is extended for a period of one year and can be of a revolving nature to fund company growth by financing increased levels of inventory and allowing the borrower to carry higher levels of receivables. The line is secured and based on a percentage of accounts receivable and inventory. Sometimes real estate is used as additional collateral.

A line of credit is also used to finance seasonal working capital needs. This type of loan is intended to be self-liquidating through the sale of inventory and collection of receivables. It fills the gap between the time payables to suppliers are due and receivables are collected.

To Finance Machinery and Equipment. Term loans are often made for the purchase of fixed assets. In this case, all funds may be advanced to the borrower at once or according to an agreed schedule for the purchase of capital assets. Usually the asset purchased is pledged as collateral for the loan along with any other collateral that may be required. Theoretically, the loan is to be repaid from the stream of earnings generated by the asset being financed.

To Finance Real Estate. Loans made by banks to finance real estate are either interim construction loans or mortgages. Interim construction loans are extended to builders and developers to finance the construction of real estate projects. The loan is normally made on a short-term secured basis using a demand note. A commercial mortgage is granted for the purchase of land and buildings and is usually a term loan secured by the real estate being financed.

Eligibility. When a commercial loan application is reviewed by a commercial bank, many factors are considered in the credit decision. Of primary concern is the protection of the depositor’s funds in the institution. For that reason, the banker’s ultimate credit decision depends upon the degree of risk he or she perceives in making the loan. Anything the borrower can offer in the form of collateral or guarantees to reduce this risk improves the possibility of a favorable loan decision. Some of the factors considered are:

• The financial condition and profitability of the borrower and his or her capacity to repay
• The reputation and integrity of the borrower
• The management ability of the borrower
• The nature of business of the borrowing entity
• The bank's expected rate of return from the transaction
• Any potential for future relationships
• The bank's internal credit policies
• Conditions in the borrower's industry
• General economic conditions
• Regulations
• Collateral value

Banks take collateral in order to reduce lending risks. However, they do not make loans that can only be repaid from the liquidation of the collateral. Any collateral offered should be readily marketable, assignable and provide a sufficient margin. The margin is known as the excess of the collateral’s appraised value over the loan amount.

The two most fundamental financial considerations made by bankers when they review loan applications are cash flow and financial leverage, or total debt in relation to total equity.

Bankers view cash flow as the primary source for repayment of loans. Therefore, the business should demonstrate adequate cash generation ability from its normal operations to service its total debt payment. In addition, bankers prefer that companies not be highly leveraged because there is a greater portion of business risk taken by creditors in relation to ownership interests. For this reason bankers tend to look less favorably on businesses with a higher leverage than the average of similar businesses in their industry.

When a bank participates in financing a business sale, it will typically finance 50 to 75 percent of the real estate value, 75 to 90 percent of new equipment value, or 50 percent of inventory. The only intangible assets attractive to banks are accounts receivable, which they will finance from 80 to 90 percent.

The estimated rate of rejection by banks for conventional financing of a business acquisition is 80 percent or higher.