Many business owners have an emotional and financial interest in maximizing the value of their business.  Yet, owners don’t often know its market value nor how to safely and profitably exit it.  Not many are able to sell their business for top dollar nor transition out on their own terms.  Unfortunately, many end up being sold in an emergency, or “fire sale”, situation which nets only a fraction of the company’s worth, often due to poor planning or timing.

In the best of economic environments, it is still often necessary for a seller to aid in financing the sale of his business.  By taking a note, the seller helps complete the funding and realize a higher price for the business.  In times of economic uncertainty and credit tightening, seller financing becomes an even more necessary part of the funding source equation. However, there are a number of issues that need to be managed prior to and during the transition process in order to protect the buyer, the seller, and, of course, the business itself.

With seller financing, the seller assumes more risk as he is dependent on the buyer to fulfill his obligations to pay the note.  Sellers must therefore do their due diligence to find buyers whose business acumen is as important as their credit worthiness.  The buyer must be able to successfully run the business in order for the note to get paid without complication.  Assuming the buyer is a good choice to take the reins, then what other issues would put the payments from the buyer or the business at risk?  If the buyer was unable to run the company due to a change in health or premature death, might the seller have to again assume control of the business or litigate to get the balance of the payments?

The buyer has an obligation to pay whether he lives, dies, or becomes disabled.  Should the buyer die, then life insurance could provide the capital to protect both the buyer and seller.  The seller is guaranteed the payments due him and the estate of the deceased buyer is relieved of the debt.  It can also provide additional funds for a planned and more profitable transition of the business.  Term insurance is an inexpensive means to cover this situation for the term of the note.

A more common scenario than a premature death is the inability of the buyer to work for an extended period of time due to illness or injury.  Yet, this situation is often overlooked in most buy/sell and transition agreements.  Should the buyer be unable to work to his full capacity, the company and the note payments would be at risk.  There are ways to mitigate this situation for the benefit of the both the seller and the buyer.

Each company and each sale is unique and requires more than a cookie cutter approach to properly establish and fund transition agreements as mentioned above.  A team, which includes an estate and tax planning attorney, can collectively work through these issues.  They need to understand how to utilize business valuations to properly establish strategies to protect the parties involved.  Should you want to learn more about protecting your business and establishing a transition plan, we’d be happy to walk you through our unique process.

Written for publication in the ROI Newsletter by:

Steve Den Herder, Partner

Commonwealth Financial Group

Steve Den Herder is a partner at Commonwealth Financial Group.  He and his team utilize a unique process for business owners to help them integrate their business plan with their financial and estate plans.