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Manage your business

How to finance a business succession plan


Dawn Papandrea

| Mar 21, 2018

Updated: 02/28/20

This is part of The Handover, an original Chase series that aims to help business owners think strategically about succession planning. It is presented by Chase for Business.

Making the decision to hand over your small business is tough. Once you've decided to sell, however, you'll be faced with another tough decision: how should you finance the deal?

It's a question that many small business owners will need to address, and soon. According to the recent Chase Business Leaders Outlook survey, 29 percent of small business owners say they want to sell, transfer or exit their business within five years, "There are different ways to finance a handover, and each way may have different advantages and disadvantages: both business and personal implications," says Josh Palmer, head of the Wealth Advisory team at JPMorgan Chase. You can sell to a family member, longtime manager, or a complete outsider. As for the deal itself, you could end up with a lump sum of cash, or you might choose to finance part of the deal.

"You can also finance the sale of your business to employees through a management leveraged buyout or an employee stock ownership plan," says Jeff White, a financial analyst with New York-based FitSmallBusiness.com, an information portal for small business owners. But these are more complicated transactions that are typically for larger companies, he adds.

Whatever you decide, the first step is to get everything in order. At a minimum, you'll need to gather three years of business tax returns, earnings statements, balance sheets, and any projections you have for the future of the business, says White. To make sure everything checks out, you'll need to work with your bookkeeper and tax accountant. White suggests you also consider bringing in a third-party certified public accounting firm as well: "They can verify that your books are accurate so that a buyer can believe in them and the future of the business," he says.

To figure out which financing option might work best, start by answering the following four questions:

1. What's your business worth?

While you'll likely need a professional to nail down the actual number, you can get a rough estimate by looking at the last three to five years of your company's cash flow, says Terry Lammers, a certified valuation analyst and author of "You Don't Know What You Don't Know: Everything You Need to Know to Buy or Sell a Business."

"Especially in small business, people sometimes have a lot of their personal expenses running through their company. If you're going to transition, you need to get your personal items off of that income statement," says Lammers.

Another thing to look at is the seller's discretionary income, says Lammers. "There are cases where the owner isn't paying himself a salary at all, or you run into a situation where the owner is paying himself a half million a year when a normal salary might be $150,000 per year," he explains.

To figure out the exact value, you'll likely need to hire a business broker, a valuation company, or a mergers and acquisitions advisory firm. Make sure that whomever you hire is familiar with your industry so they can fairly and accurately determine the value of your company.

2. What could you be doing better?

If your buyer is seeking financing, the lender will do their due diligence to look for any potential weaknesses of the business, says White, so try to get ahead of it. "You'll need to make sure you can talk through these weaknesses and know why the business is a good investment in spite of them," he says. If you don't disclose any potential pitfalls, you may risk breaking the trust of the buyer and sabotaging the sale.

3. Do you need an income stream?

While the idea of making a clean break might appeal to you, experts say that it may be in your best interest to finance part of the deal. Seller financing allows you to act as the lender so that the buyer only pays a portion of the sale price up front, and then pays you in installments and with interest for the remainder. The upside: since the buyer doesn't have to put up all the money, it may open up your pool of buyers.

Plus, if you're planning to retire after the sale, seller financing will give you an ongoing income stream. Your financial adviser can help you figure out whether that's an essential part of your retirement plan. "We can look at the different options and at least tell you which one would be most beneficial for your personal financial goals," says Palmer.

With that said, seller financing does have its caveats. "When the seller is financing part of the deal, he or she should make sure the buyer has the financial wherewithal to run the company," says Lammers. That includes asking for financial statements and running a background check on them to make sure he or she is a qualified buyer.

4. How will you protect yourself?

Many people think they will sell a company for a million dollars and get a check to secure their retirement, but it's rarely that simple. No matter how well you know or believe your buyer is trustworthy, it's essential to make sure you have a paper trail that spells out the specific terms of the sale. You'll need the help of a qualified attorney to prepare the necessary buyer and seller financing agreements. You'll also need a plan in place in case the buyer stops paying you. For example, you might need to file a UCC lien against the business assets, which essentially allows you to re-take possession of a portion of the business until the debt is paid.

There are all kinds of tax implications when businesses change hands, so it's important to consult your financial adviser on how to minimize the tax drain.

Finally, have patience: in general, it takes six to 12 months to arrange a sale—even once you have a buyer. In the meantime, no matter how impatient you are to retire, make sure to continue with business as usual: given that your cash flow figures are the key ingredient in the valuation of your firm, it's critical not to let them dip. Says White: "Don't take your foot off the gas pedal."