Falling Into The Capital Gap: Baby Boomer Owners and Buyers Face A Big Problem

When business owners (especially baby boomer owners) and potential buyers learn that they can rewrite the rules for business selling, sell their businesses more quickly, with fewer hassles, and create a lifetime stream of income … they are usually skeptical. After all, most of us have come to believe the old chestnut, “If it looks…

When business owners (especially baby boomer owners) and potential buyers learn that they can rewrite the rules for business selling, sell their businesses more quickly, with fewer hassles, and create a lifetime stream of income …

they are usually skeptical.

After all, most of us have come to believe the old chestnut, “If it looks too good to be true, it probably is.”

The idea that one can formulate workable, proven solutions for all of the problems plaguing the sale of a business causes some buyers and sellers to become a bit skeptical.

It's easy to understand this mindset. The old method of selling a business just is not working and the horrible 3% success rate proves it.

Many times, business brokers claim that they can resolve some or all of an owner's concerns when selling a business.

But there are also lots of problems for potential buyers. These issues absolutely became the seller's problem as well. How can old, outdated methods of selling possibly address issues that buyers have that often result in “sale fail?”

Let me give you a snapshot of a few of the top issues facing those who want to buy successful businesses.

The growth cycle for businesses mirrors the growth cycle for people. They're born, they grow quickly, hit adolescence (which is a pretty funky time), and then reach young adulthood where they can usually take care of themselves without someone watching them every second of the day. Young adulthood is followed by middle-age, where everything starts firing on all cylinders. Businesses have similar experiences in this “prime” period.

Then, something strange happens. People experience a “mid-life crisis,” a time when life seems to be an endless treadmill where one either advances nor retreats and where longings are difficult to define and nearly impossible to satisfy. In business, this period of angst-filled transition is called ” No Man's Land”. It is a place where boulders can roll down on both sellers and buyers.

Let's take a look at some of the more obvious barriers to a successful sale. These are barriers which end up being a major headache for anyone who wants to exit his or her business.

1. Falling into the “Capital Gap”

The capital markets are interesting, organic creatures. Capital likes what it likes, and hates what it hates, seemingly without rhyme or reason.

Deals have to meet certain criteria to attract particular types of financing, and if they do, there are typically many sources. But the ones that do not meet all of these certain criteria usually can not attract a single source of capital. This makes financing for businesses (the life blood of a selling a business) in the “Capital Gap” a tricky proposition.

There are three general categories of businesses: small, medium, and large. Small businesses get financed primarily by commercial banks that view business loans as individual loans and qualify the business owner based on personal criteria. These banks can make some loans, but only up to certain limits-no more than the borrower can personally repay. Those are critical words … “personally repay”. For most banks, there is a limit of $ 500,000 for bank loans, and this constituents the “floor” of the capital “gap”

For large businesses, the opening financing amount for capital tend to be about $ 5 million (the “ceiling”). Institutions interested in financing these kinds of business deals are primarily commercial banks (the commercial division), venture capital companies, corporate financing arms, and private equity companies.

The problem for such institutions is that loan acquisition and servicing costs combined with risk-adjusted returns to the investors prevent these institutions from profitably making loans at anything less than a 25% rate of return (interest rate). Obviously, this is a non-starter for businesses as these usurious costs of capital would put the enterprise into a chokehold.

“So what does this mean, to you as a seller or buyer?” you may be asking.

The cold, hard truth for mature small and medium businesses who are stuck between the floor and the ceiling is that there is simply no capital for your deal. Zilch, zip, nada …

It's a sobering reality, and it underscores the number one problem for business buyers .

It is a big problem too, because the logical extension of this reality is that not having capital for buyers also because there is no capital for sellers either.

Both buyer and seller are in a world of pain due to this fact. As a seller or buyer, you need to find a solution that addresses this lack of capital in a real way by eliminating the middlemen (banks, brokers, finance companies) who drain the capital well dry.

2. It's impossible to structure a deal that makes sense

Even with an “all cash” deal structure on a $ 1 MM cash flow acquisition (which NEVER happens by the way), a seller would get, say, $ 3 MM in cash up front and pay at least half of that to brokers, lawyers, accountants, lenders and tax authorities leaving them with about 1.5 MM (if they're lucky).

Only if a seller is then also very good at investing and minimizing broker / transaction fees on the investment they then buy, they might be able to net $ 150 K per year (10%), which is then taxable and subject to inflation.

Going from $ 1million in income a year to $ 150,000 is a big hit. Are you really willing to downsize that much?

Even if a seller took back a 5-year seller note at a market rate of interest, they would get approximately $ 360K for the first five years, but the tax authorities would have taken out taxes on the capital gains and income taxes on the interest, leaving a seller with “skin and bones”. This is a 5-year note, remember. The checks stop coming at that point and the asset column becomes bone dry.

Conversely, out of a buyer's 1 million in cash flow comes the $ 360 K in debt service to the seller and approximately $ 600K to the bank, leaving a paltry $ 40 K net for the first five years for a buyer to put in his pocket- no joy for any professional business buyer, particularly given the risks involved.

In this instance only the broker, the banker and the taxman make any money on the deal. You simply must discover a way to avoid this situation by cutting out the middle men altogether. After all, why should the broker, the banker, and the tax man get all of the profit from your hard earned efforts?

3. A buyer has to make personal guarantees to a bank or other lender.

Another issue Buyers must deal with is that they have to make personal guarantees to banks and other lenders.

Such guarantees provide zero benefit to sellers. Any astute buyer will structure their finances in such a way that a deal going bad will not sink them.

Bankruptcy protection ensures that sellers will not get paid out of a personal guarantee. Banks know this but use it as a limit on loans, and will often only loan to wealthy people with exposed assets.

This really puts the buyer at risk for 200% of the guarantee -100% off the business plus another 100% from additional assets at risk. A proper response to this untenable situation would have to collateralize its guarantee.

Finding a trustworthy advocate to provide you with such a collaterlized guarantee will not be easy. However, if you want to ensure selling success, you need to commit yourself to doing exactly that.

With such a collateralized guarantee in place, you are able to minimize the risk of default for the seller and ensure that the assets pledged are not protected via the bankruptcy statutes, as they would be with a personal guarantee. This makes it real and ensures that it will not take lawyers to get recourse if a deal goes sideways.

As you can see, if you are a small to mid-sized business owner who wants to sell, or someone who wants to buy such a company, you must fix the financing issues for both buyers and sellers. Otherwise, you wind up be forced into deals that are the opposite of what you want and need.

Finding a method of selling where financing is built right into the deal will greatly improve your chances of success.

Do not even bother looking for this kind of selling blueprint at your local business brokerage. The typical business broker, whose emphasis is on making the highest commission possible rather than solving problems, simply lacks the skills, tools, and training to set this situation up for you.

Instead, look for seasoned business transition experts who understand every problem facing both buyers and sellers and have proven solutions in place for each and every one of those issues.