How important is the term of the lease?

The lease terms are certainly importance for any business. Could I determine my interest level in a business based on current lease terms alone? No. Some buyers get hung up, during our first phone call, on the remaining term of the lease. There are pros and cons to everything in life, and it is no different here.

Today, we are more likely than not going to find a lease that is above current market rates. Would it be a benefit to a buyer to have this premium rate locked in long-term? Of course not. The biggest benefits to a buyer to have a long-term lease in place is if the lease terms were below market (not too likely), if the location is crucial to the businesses success, or if it would be cost prohibitive to move.

Regardless of the remaining lease term, a buyer should always have a lease contingency in their purchase offer. If you use a standard California Association of Business Brokers form, there are checkboxes in the lease contingency paragraph for either a) buyer obtaining a new lease, or b) buyer getting an assignment of the lease.

When the buyer has fully assessed the businesses viability, they will be in a position to determine if they want the lease assigned, as is, or if they'd like a new lease. In today's environment, landlords do not have the upper hand in negotiations. Landlords will still be stubborn, and will still kill transactions, though now more than in recent years you are likely to come across a more humble landlord, and you will hopefully get a new or restructured lease which will save you money and help the business be more profitable.

Seller Financing

When I meet with a client for the first time, I always ask if they've considered providing part of the financing for the sale of their business. The answers are either "I'd rather not", or "Do you think I need to do that?"

Here are the options:
1) Cash buyer
2) Down payment with SBA financing
3) Down payment with seller financing

1) Cash buyers are the preference. Here is the stumbling block. As far as a buyer's expectation, they typically want to use their cash for leverage. If someone has $150,000 for a down payment, here are some of their options:
a) Buy a business for all cash. Positive is that there is no debt service. They are probably buying a business netting $80,000-$100,000 a year.
b) Buy a $500,000 business, with $100,000 down, and $400,000 financed through SBA, or combination of SBA and owner financing. They SBA will typically require a 20% down payment, so the buyer can get leverage on their money. They can probably get a net income before debt service of between $200,000 and $300,000. So, after debt service, they are likely netting more than the $80,000 - $100,000 they could net if they paid all cash.

So, although the preference of the seller is to find a cash buyer, the buyer is better off leveraging their capital and simply making more money. Also, a general rule of thumb is that a buyer expects to be able to earn whatever amount they are using as their down payment. Again, rule of thumb.

2) SBA financing. In order for the business to qualify for SBA, you need at least these 4 circumstances to be met.
a) The business needs the past 3 years of tax returns (you'll be shocked at how often the seller won't provide tax returns)
b) The tax returns need to show enough profit that it covers debt service by at least 1.25-1.35 times (the bank wants a 25-35% cash flow cushion above the debt service amount).
c) The tax returns, after showing 1.25-1.35 times debt service coverage, needs to provide a livable wage for the buyer. The SBA will have them fill out a form that lists all of their expenses, and they have to be able to earn a certain percentage above having all of their expenses paid.
And, if that isn't tough enough...
d) The buyer needs industry experience, or experience transferable to the business.

So, it isn't that bank or SBA money isn't out there, it's difficult for a business to qualify.

3) And that's why the seller typically needs to provide some sort of financing for the buyer's purchase. They'll get a personal guarantee from the buyer, we will receive a copy of the buyer's credit report, proof of funds in the bank and investment accounts, a note evidencing the debt, and a lien on all equipment of the business.

Trends in Small Business Acquisitions

The most common question I receive is, "How is business." And I'm never sure the best way to answer that. Should I plug my services and skillsets, or just answer the question?

In the small business arena, there always seems to be people interested in buying business, and people selling businesses. Are the buyers real, and are the sellers serious? Those are two questions I ask myself multiple times a day.

Industry statistics show that roughly 9 of 10 buyer calls to business brokers ultimately never buy a business. So, my biggest job is trying to find out if someone is serious or not. You can tell the serious sellers mostly by how they price their businesses.

The biggest trend I see now is the reason behind the sale of business. There are more businesses now that are selling because they are losing money, and they should shut down. A buyer needs to be thorough in their due diligence, especially when it comes to the reason behind the sale, and the likelihood of the business continuing. I'd ask the seller or their representative in the first communication why the seller is selling (almost everyone does). I'd make a note of that and make sure the story doesn't change over time, and that it makes sense as you get more information.

The next big trend is the way business purchases are getting financed. It's harder to get SBA financing, though it was pretty difficult before the financial markets imploded. The two most popular ways businesses are financed today are either cash, or cash with seller financing.