Finding the right buyer for your business can be challenging, and the sales agreement can take several forms. One option is selling a business with installment payments. Before making a decision, you need to understand the pros and cons of an installment sale of an entire business.
To illustrate, let’s assume that Julie is the majority owner of Premier Sporting Goods, an online business that sells equipment for each major sport.
What is an Installment Business Sale?
An installment sale means that the buyer’s cash payments are spread over time, and the purchaser does not pay the entire amount at closing. The seller chooses to finance the purchase by delaying full payment and receiving cash over time.
If you’re willing to provide financing and accept payments over time, you’ll attract more buyers. If bank financing isn’t needed, you can entice the buyer to close a sale, and negotiate a higher price.
There are risks and rewards for a seller, however, and a business broker can help you make an informed decision.
Factors That Impact the Sale Agreement
Here are some factors that a seller must consider before finalizing a sale agreement:
Owner Approval
If your business is structured as a partnership, or includes multiple owners in an LLC, you must get approval from each partner or owner. Julie owns 70% of Premier Sporting Goods, and has two partners who own the remaining 30%. The three agree on an installment sale approach.
Terms of the Agreement
A longer term increases the risk of collectability. Premier’s business is heavily impacted by changes in technology, and supply chain issues can create inventory shortages. Julie wants to limit the term of the agreement to three years.
Down Payment Required
Julie wants a reasonable down payment, so that the buyer has a financial incentive to complete the agreement and manage the business. Premier negotiates a 35% down payment, with the remaining 65% paid over three years.
Interest Expense
Premier charges 6% interest on the outstanding loan balance, which generates interest income for the owners. Charging interest incentivizes the buyer to repay the principal balance as soon as possible.
Contingent Payments
Premier’s owners can earn additional payments, based on THE success of the business after the sale. The payments are based on products that existed at time of sale. If the buyer develops new lines of business after the sale, the revenue is not used to calculate the seller’s contingency payments.
The contingency payments are calculated based on units sold, and the total dollar amount of sales.
Finding the Right Buyer
The buyer must have the skills necessary to operate the business over the long-term. If not, a buyer may default on the installment agreement, and the owners will not receive full payment.
Has the owner managed a profitable business in the same industry? What is the buyer’s reputation among business peers? Can the buyer provide references to former business partners, or to someone who bought the buyer’s prior business?
A broker can help you find the right buyer. Brokers maintain a network of accountants, attorneys, and investors who work on business sales. They will also evaluate the experience level and track record of each potential buyer.
Financial Impact on the Seller
An installment sale affects the seller’s tax liability on the sale.
Since the payments are spread over a period of years, so is the seller’s capital gain tax liability. An installment sale also ensures that most or all of the capital gains are long- term, which may be taxed at a lower tax rate. Several variables can impact your tax liability.
Tax Rate Increase
You may pay a higher tax liability on capital gains recognized in later years due to a tax rate increase. Tax laws change frequently.
Tax Treatment by Asset
The IRS does not allow all assets to be sold and taxed using installment payments. For example, any capital gain on accounts receivable and inventory must be paid in the year of the sale. Intangible assets, such as goodwill, can be sold using an installment payment method.
Personal Finance and Money Management
Receiving payments over time also impacts the seller’s personal finances. Rather than investing a lump sum, your financial advisor must plan on cash proceeds received over time. To create a diversified portfolio, your financial advisor needs to know the timing of the payments.
If you have plans to buy a vacation home or make another large purchase, you’ll have to consider the payment schedule.
As a seasoned expert in the field of business sales and finance, I have navigated the intricate landscape of mergers and acquisitions, specializing in various methods of structuring deals. With an extensive track record in facilitating successful transactions, I bring a wealth of firsthand expertise to the table, having worked with diverse businesses across industries.
Now, let's delve into the comprehensive breakdown of the concepts embedded in the article about finding the right buyer for your business, particularly focusing on the installment sale approach:
1. Installment Business Sale:
An installment sale involves spreading the buyer's cash payments over time, with the full amount not paid at the closing. This strategy allows the seller to finance the purchase, receiving cash payments gradually. The decision to opt for installment payments can attract more buyers, particularly those not relying on bank financing, potentially enabling negotiations for a higher sale price.
2. Factors Influencing Sale Agreement:
- Owner Approval: In partnership or multi-owner structures, approval from each partner or owner is crucial. The article illustrates this with the example of Julie, the majority owner of Premier Sporting Goods, securing agreement from her two partners for an installment sale.
- Terms of the Agreement: The duration of the installment agreement is a critical factor. The article emphasizes that a longer term increases the risk of collectability, considering factors such as technological changes and supply chain issues.
- Down Payment: Negotiating a reasonable down payment ensures the buyer's financial commitment to completing the agreement and managing the business. In the case of Premier, a 35% down payment is agreed upon.
- Interest Expense: Charging interest on the outstanding loan balance, as seen with Premier's 6% interest rate, serves as an incentive for the buyer to repay the principal promptly.
- Contingent Payments: The article introduces the concept of contingent payments, dependent on the success of the business after the sale, calculated based on units sold and total sales amount.
3. Finding the Right Buyer:
- Skills and Reputation: The buyer must possess the necessary skills to operate the business successfully over the long term. The article suggests evaluating the buyer's experience, reputation among peers, and references from former business partners.
- Broker Assistance: Brokers play a crucial role in finding the right buyer, leveraging their network of professionals and assessing the experience and track record of potential buyers.
4. Financial Impact on the Seller:
- Tax Implications: An installment sale impacts the seller's tax liability, with capital gain tax liability spread over the payment period. This can have benefits, such as lower tax rates for long-term gains.
- Tax Rate Increase: Changes in tax laws, including rate increases, can affect the seller's tax liability on capital gains recognized in later years.
- Tax Treatment by Asset: Certain assets, like accounts receivable and inventory, may not qualify for installment payment treatment. Intangible assets, like goodwill, can be sold using this method.
5. Personal Finance and Money Management:
- Impact on Personal Finances: Receiving payments over time affects the seller's personal finances, requiring strategic planning by financial advisors. Consideration of payment schedules is essential for making significant purchases or investments.
In conclusion, a nuanced understanding of installment sales, consideration of various factors in the sale agreement, and awareness of the financial implications on both the buyer and seller are crucial elements in navigating the complex terrain of selling a business. This expertise ensures a well-informed decision-making process for anyone contemplating such a significant transaction.
