You have found your dream business venture to invest in and made the decision to buy. Now you have to figure out you are going to pay for the purchase of a business. There are many ways to pay for a new business, here is are some of the most common: having cash at closing, seller financing, or contingent payments and securities issued by the purchaser.
Having cash at the closing is the absolute simplest form of payment. However, the cash usually comes from a small business administration (SBA) or bank loan to fund the acquisition. Generally, the bank loan is secured by putting a blanket lien (Uniform Commercial Code or UCC filing) on all assets of the acquired business. These loan agreements often contain covenants that restrict the buyer’s business operation in some form. Banks will require all corporate minute books and legal relationships to be kept in proper order. Most start-ups applying for a loan for the purchase of a business require that the principal have a significant personal net worth.
Given the difficulty of obtaining bank loans, I generally recommend private seller financing to clients in this situation. This is when the buyer will issue a promissory note to the seller at closing with a repayment schedule. The seller financing will simply be deferred payments of the purchase price per the terms of the purchase agreement. Like the bank the seller will also require a lien (UCC filing) on transferred stock and or assets to secure the debt.
One advantage of the deferred payments to the seller is the possibility of installment tax treatment of payments. This allows the seller to recognize income from the sale of the business in the year in which payment is received instead of taking all of the income in the same year, which can result in lower taxes.
An advantage to the buyer is that the promissory note can contain a right of set-off. This means that if liabilities of the seller are discovered after the closing, the buyer can pay those debts and deduct the amount of installment payments due to the seller under the note. This gives the buyer peace of mind and enables him to pay for the purchase of a business when it might otherwise be beyond his reach.