A surprise that some entrepreneurs encounter when buying a small business is that the amount of money expected to go into the purchase will not cover every expense involved in becoming the new owner. Not only is it necessary to come up with the down payment, but in order for the business to succeed the buyer will need working capital when taking over. Smart strategies for raising that extra money include:
1. Seller Financing: If the deal calls for an all cash purchase, and the buyer is emptying his bank account to pay off the seller, perhaps the agreement can be modified to include a promissory note to be used by the buyer for part of the price being paid. That will free up some of the cash originally intended for the down payment. The seller may find tax benefits to this arrangement. Besides, making sure the buyer has sufficient working capital is an important way to help her succeed.
2. Inventory On Consignment: The buyer can save the money that would ordinarily go for purchase of the inventory at close of escrow, by paying the seller the wholesale costs for inventory items only as they are sold to customers of the business. Rather than the buyer’s several hundreds or thousands of dollars tied up with parts or products, it can be used for other expenses and the seller will be paid for each item of inventory as the buyer sells it.
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3. Earn-Out Agreement: Another way for buyer and seller to work together to make sure the business won’t run into trouble for lack of working funds, is their agreement to establish a lower selling price than was originally planned. That can call for a lower down payment than the amount stated in the sales agreement. The seller will be compensated later, under the earn-out provision of the sales contract. It would specify that the price is linked, by an agreed-on formula, to a specific low performance level for the business. As the business outperforms this initial projection, the price would rise according to that formula. That means the seller sacrifices at first, with lower payments for the balance of the price than he wanted. But as the price of the business goes up, so will the amount owed to the seller, as expressed in larger payments.
4. Borrow From Financial Institution: The buyer may be able to get extra money from a bank or other financial institution. If there is seller financing involved in the deal, another lender is more likely to agree to approve an application for a loan to help fund working capital. And it’s a good idea for the buyer to start shopping among financial institutions before he or she finds a business to buy. That way the buyer will know which company is likely to offer the needed cash.
5. Assume Seller’s Debt: If the seller will need cash at close of escrow to pay off business creditors and deliver the business free and clear of debt, the buyer may be able to assume that debt instead. That will require the cooperation of the vendors to the business. Some or all are likely to go along with the plan as it will insure their continued relationship with the business.
A shortage of cash to take over a business need not stop a buyer from proceeding if he or she can use one or more of these methods to raise additional funds before taking over the business.