Many times a selling owner has to hold paper as part of the sales transaction. Often the buyer just doesn’t have enough credit and can’t get a bank to loan them enough money to buy your business. Other times you as a seller are required to hold paper because the buyer is worried about something happening that could decrease the revenue of the business they bought.
Some negative issues could be losing customers, having lawsuits appear that the buyer didn’t know about, or employees riding off into the sunset with customers that used to be served by your business. These are all legitimate concerns and as a seller you need to do everything in your power to minimize the chance of any of these things happening when it comes time to sell your business.
If you’re a bank, act like a bank.
If you have to provide owner financing make sure you get security agreements in place that make sure you’ll be paid if for any reason the buyer decides to stop paying. This means that you need real assets behind the buyer’s promises. If the buyer can’t provide security, then realize that there is a chance and often a good chance you won’t get all of the money that is owed you.
I’ve seen it too many times: A seller (you) finds someone to buy their business. The buyer doesn’t have enough cash and can’t get financing from the bank to pay you cash. Your broker or intermediary says that if you want the deal to close you’ll have to provide owner financing. You agree because you don’t think you have any other options.
Fast forward to a year or eighteen months down the road. Your buyer has made some really dumb business decisions. As a result their business is suffering. They decide that they have to save money somewhere. Guess where they’re going to look? Yup, that’s right, there going to look at that nice monthly payment they make to you. First they’re going to start making late payments. Before you know it they’ve managed to miss a payment or two. Then your buyer has really screwed up the business. They don’t have the cash to pay you and just plain stop paying you at all.
Now you try to collect but it’s too late. There is no money in the business, the business isn’t worth anything because the buyer has ruined it, and you don’t have any recourse because that personal guarantee that you thought had value turns out to have no value. This story happens way too often and too often has the same result: Buyer gets business, buyer ruins business, seller doesn’t get paid.
Instead have the money owed you put in escrow.
This requires that you only sell to people who can afford to buy your business. If possible you don’t want to play bank. If you’re being the bank it’s because your buyer likely has bad or insufficient credit to buy your business.
There are many times where the buyer does have the ability to find credit, but finds it more convenient, cheaper, or would just rather have you provide the buyer credit instead of a bank. If you provide credit to a buyer you are taking a big risk. Not only are you hoping they continue to have the money to pay you, but you are making a bet the buyer has the ability to run your business well.
If you have the ability to have the buyer place money that’s owed you in escrow you know at least the money is there. If things go poorly for the buyer you have a chance to collect what’s owed to you. You may end up having a good argument about whose fault it is that the business went bad. At the same time the money is in escrow and as long as you’ve held up your end of the bargain you have a chance of collecting the money that’s owed you.
Using an escrow to hold money is not a guarantee you’ll get paid. At the same time it’s way better than just providing plain old vanilla owner financing. If you’re taking a risk in selling your business do the best that you can to limit the risk you have. Limiting your risk could be the difference between getting paid the money you’re owed and not getting paid.
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