Financing Goodwill
The definition of goodwill is the sale price minus the resale or
liquidation value of business assets after any debts owing on the assets
are paid off. It represents the future profit the business is expected
to generate beyond the current value of the assets.
Most lenders have no interest in financing goodwill.
This effectively increases the amount of the down payment required to
complete the sale and/or the acquisition of some financing from the
vendor in the form of a vendor loan.
Vendor support and Vendor loans are a very common elements in the sale
of a small business.
If they are not initially present in the conditions of sale, you may
want to ask the vendor if they would consider providing support and
financing.
There are some excellent reasons why asking the question could be well
worth your time.
In order to receive the maximum possible sale price, which likely
involves some amount of goodwill, the vendor will agree to finance part
of the sale by allowing the buyer to pay a portion of the sale price
over a defined period of time within a structured payment schedule.
The vendor may also offer transition assistance for a period of time to
make sure the transition period is seamless.
The combination of support and financing by the vendor creates a
positive vested interest whereby it is in the vendor's best interest to
help the buyer successfully transition all aspects of ownership and
operations.
Failure to do so could result in the vendor not getting all the proceeds
of sale in the future in the event the business were to suffer or fail
under new ownership.
This is usually a very appealing aspect to potential lenders as the risk
of loss due to transition is greatly reduced.
This speaks directly to the next financing challenge.
>>> Business Transition Risk
Will the new owner be able to run the business as well as the previous
owner? Will the customers still do business with the new owner? Did the
previous owner possess a specific skill set that will be difficult to
replicate or replace? Will the key employees remain with the company
after the sale?
A lender must be confident that the business can successfully continue
at no worse than the current level of performance. There usually needs
to be a buffer built into the financial projections for changeover lags
that can occur.
At the same time, many buyers will purchase a business because they
believe there is substantial growth available which they think they can
take advantage of.
The key is convincing the lender of the growth potential and your
ability to achieve superior results.
>>> Asset Sale Versus Share Sale
For tax purposes, many sellers want to sell the shares of their
business.
However, by doing so, any outstanding and potential future liability
related to the going concern business will fall at the feet of the buyer
unless othewise indicated in the purchase and sale agreement.
Because potential business liability is a difficult thing to evaluate,
there can be a higher perceived risk when considering a small business
acquisition loan application related to a share purchase.
>>> Market Risk
Is the business in a growing, mature, or declining market segment? How
does the business fit into the competitive dynamics of the market and
will a change in control strengthen or weaken its competitive position?
A lender needs to be confident that the business can be successful for
at least the period the business acquisition loan will be outstanding.
This is important for two reasons. First, a sustained cash flow will
obviously allow a smoother process of repayment. Second, a strong going
concern business has a higher probability of resale.
If an unforeseen event causes the owner to no longer be able to carry on
the business, the lender will have confidence that the business can
still generate enough profit from resale to retire the outstanding debt.
Localized markets are much easier for a lender or investor to assess
than a business selling to a broader geographic reach. Area based
lenders may also have some working knowledge of the particular business
and how prominent it is in the local market.
>>> Personal Net Worth
Most business acquisition loans require the buyer to be able to invest
at least a third of the total purchase price in cash with a remaining
tangible net worth at least equal to the remaining value of the loan.
Statistics show that over leveraged companies are more prone to suffer
financial duress and default on their business acquisition loan
commitments.
The larger the amount of the business acquisition loan required, the
more likely the probability of default.
