The economy is bad and many businesses have experienced depressed earnings for several years, making them prime targets for savvy purchasers hoping to position themselves for the recovery we have all been waiting for. While prices for those businesses are at a low point, so is the availability of traditional bank financing necessary to buy them. Below are some of the options, other than traditional bank financing, that may be available, individually or in some combination, to some of those purchasers:
– Seller financing – The seller makes a loan to the purchaser of some portion or all of the purchase price. The seller, like a bank, will most likely require the purchaser to provide collateral and possibly a personal guaranty for this loan.
– Small Business Administration (“SBA”) 7(a) loan – The SBA offers programs that aid small businesses get needed financing. Go to www.sba.gov for more details.
– 401(k) rollover – With this scenario, the shareholder of the new purchasing corporation rolls over an existing 401(k) account to a new 401(k) account established for the shareholder by the new corporation. Then the new 401(k) account purchases stock of the new corporation for cash. The new corporation then uses the cash to purchase the target business. To avail yourself of this opportunity you should consult with your tax advisor to make sure you comply with all of the federal tax requirements.
– Loans from friends and family – Loans from friends and family remain an option, but typically by themselves will only finance a small portion of the purchase price.
– Earn-outs – This tool enables the purchaser to determine and pay a portion of the purchase price based on the actual earnings of the business for some limited period of time after the purchase. This tool is especially useful for those hard-to-value businesses where future earnings and cash flow are difficult to predict.
– Bonus Plans – The employer sets up a bonus for a valued employee who will one day take over the reins. Under this plan, bonus payments received by that valued employee are used to purchase the stock of the other shareholder(s).
– Mergers and other acquisitions using stock of purchaser – For a purchaser wishing to expand a businesses, this could be a tax-free way for a seller to convey its businesses. Again, tax advisors should be consulted to guide you through the tax minefield.
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– Options – An option to purchase, while not widely used, is a way for a purchaser to monitor and study, and possibly be employed by, the business before committing to buy the business. Should a purchaser exercise the option, the option payments could then be allocated toward the purchase price to the extent the purchaser and seller agree to do so.
The present economy presents numerous challenges, but the adverse business climate also presents opportunities for savvy investors seeking to purchase new businesses. If you are an investor seeking to purchase a business and would like more information regarding any of these options, please contact Greg Johnson, attorney and CPA, at (434) 817-3100 or by email at [email protected].
An attorney and certified public accountant (CPA), Gregory M. Johnson, the author of this post, is an attorney and certified public accountant in the Charlottesville, Virginia office of MartinWren, P.C., where he chairs the Business, Corporate, & Tax Law practice area. Greg has advised numerous investors on tax and business law issues associated with the purchase and sale of businesses, and he has presented state-wide legal education programs on some of the intricacies of limited liability companies in Virginia.
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