One of my favorite boat supply online stores has closed, and the story is worth repeating to all business owners. The founder of this company sold the business and took a note as partial payment. The new owners have defaulted on the note, closed down the business, and the old owner is now facing re-opening the shop to recoup some of the money he should have been paid.
The same thing happened to a friend of mine who sold a business a few years ago, and he's now behind the banks in priority to get paid from the few remaining assets of the business.
Before criticizing the practice, remember there are good reasons for the sale of a business on a note:
- Seller financing increases the number of potential buyers
- Seller financing increases the likely purchase price (assuming the buyer pays off the note!)
- Seller financing give the seller a stake in the success of the new owner, which is likely to help with transition issues.
- Seller financing signals to the buyer that the owner is confident that the business will succeed under new ownership.
The downside, of course, is the the seller gets a note rather than cash. Here are some steps to take to reduce your risk when you sell the business:
- Get a substantial portion of the price in cash up front. If you don't, you are merely giving away an option, not selling the business.
- Ask yourself if the buyer really does have the skills and temperament necessary to succeed.
- Run a credit check on the buyer.
- Ask if the buyer has other assets that can be pledged to secure the loan.
- Set up some loan covenants, such as the buyer needing to maintain a certain level of working capital or a particular level of net worth. That allows you to step in early if the business starts going downhill. (You may need to ask a banker for advice; they do this sort of thing all the time.)
- Demand regular audits to ensure compliance with the covenants, and also that the business is being run honestly. If you need to take the business back, it's imperative that you not have to clean up ethical issues left behind by the buyer.
- Stay in touch with major customers. Know if they are unhappy or cutting back their orders.
- Sketch out a contingency plan for taking back the business. There may well be some simple things that will help you if worse comes to worst. Think it through ahead of time.
- Do not sail around the world, trusting that all will turn out well (unless you can afford to walk away from the unpaid balance on the loan.)