Credit: Jacob M. Dietz, CPA
Imagine you are a business owner, and the time has come to sell the business. You wipe away a few tears, and you begin to negotiate with a potential buyer. How much will you get paid? That answer may depend partially on how you get paid. This blog explores some options for getting paid.
Getting paid in cash may be attractive for a seller. After the seller has the cash, they can take the money and do with it as they please. They have the security of getting the cash in hand immediately.
One drawback to the cash sale for the seller is that it brings all the income from the sale into one year. That can throw the seller into higher tax brackets, and they may potentially lose out on credits. On the bright side, if they have a large tax bill from the sale, then at least they have cash to pay it.
With a cash deal, there is less risk to the seller. Consequently, they may not get as much cash for the sale. On the other hand, there may be more risk to the buyer. Therefore, the buyer does not want to pay as much.
Although I am calling this cash, it is cash from the seller’s perspective. For the buyer, the cash could be savings, or perhaps bank debt, or some other source of cash. Calling it cash does not mean that the buyer is debt-free. In fact, in a cash sale, the buyer may be deeply in debt, which can be risky.
Another option for the sale is where the buyer agrees to pay the seller for the business, in the form of a loan, over time.
This arrangement increases the risk to the seller. What if the buyer defaults on the loan? The economy might go bad, and even an honest buyer may not be able to pay. Worse yet, the buyer may be dishonest and simply refuse to pay. With the increased risk comes the possible opportunity for a higher sales price. The seller incurs more risk, so they may ask for more money. On the other hand, the buyer may have less risk, at least if it is unsecured debt, and they may be willing to pay more. Also, there may be more potential buyers if the seller is willing to finance it.
How could there be more potential buyers? If a business would be for sale for $600,000, then there would be many people who could not afford that price, even if they wanted to buy it. A bank may offer some financing, but if the buyer does not have a significant enough down payment, the bank may not help them. On the other hand, if the seller finances it, then what was impossible may become possible with seller-financing. The seller and buyer might agree to some type of middle ground in which some of the sales price is paid immediately in cash and some is seller-financed. For example, if the total sales price of the business is $600,000, the seller may ask for $300,000 in cash and offer a 7 year note for $300,000.
Another part of the sales price could be a contingency. There could be different contingencies, but let’s use revenue as an example. The deal could specify that if revenues in year 1 equal $X, then an additional $20,000 or will be paid to the seller. A contingency can help reduce the risk of the buyer.
How and How Much
How the seller gets paid can affect how much they get paid. If the seller is taking on more risk, then they may want to ask for more money. On the other hand, if the buyer is taking on more risk, then the buyer may want to pay less. How the seller gets paid, therefore, may affect how much they ask to get paid.
If you are selling or buying, remember to think about both how the payments will be made, and how much they will be. Deals can be complex, and you will likely want to consult with your accountant on important deals.