How to Choose Between Lump Sum and Financing

By Thursday Bram on 27 July 2010 0 comments
Photo: lisegagne

When selling a business, you might be expecting to get one big payment for your company. But there are actually two main strategies that buyers rely on to pay for a company: lump sums and financing. With a lump sum, the seller receives payment in full for the company before handing over control. With financing, however, the buyer makes regular payments for the company after taking control, effectively putting you in the position of a lender. Choosing between these two options can make or break a deal.

Choosing Between Lump Sums and Financing

The decision between a lump sum and financing the purchase of your business can be a difficult question for many sellers. Kumi Bradshaw provides help with appraising businesses for sale and completing the sale process. Bradshaw describes the situation and potential problem:

Many sellers instinctively want to take a lump sum because if they are going to divest themselves of control of the business, they want to harvest the full economic value in cash. The repayment risk is something many sellers are leery of. There is always the concern that the buyer may not pay the amount owed for any number of reasons: 1) changes in economic conditions; 2) less effective management; 3) unwillingness to stand by the terms of the transaction... The preferred path that I see is for sellers to take the cash — this is a general preference. In today's environment however, where there is reduced bank liquidity for business purchases, I am seeing sellers who are more motivated to consider structured deals, where financing or other options come into play (this may be simply to be able to sell the business or it may be to increase the total economic value harvested in the transaction).

Financing is typically a consideration when a buyer won't be able to actually come up with a lump sum payment, making it a less ideal option in many situations. On the other hand, there can be ways to make financing work, Bradshaw says:

Financing in the form of a seller's note or some other transaction is often used in private business transactions to help 'bridge the gap' between the debt financing that the buyer can get from a bank or other institution and the transaction price that the parties agree on. Sometimes, if a seller owns the building in which the business is housed, they may sell the business contingent on the buyer paying an above-market lease rate to the landlord (the seller). This mechanism can be used to give the seller a continued income stream, give the buyer added security regarding location and a bit more liquidity at the time of purpose.

Determining the Needs of a Specific Deal

Aetius Romulous sold his business for a lump sum after considering all of his options. He knew from the beginning of negotiations that a lump sum would be his best choice.

This depends on two things: the ability of the purchaser to honor the deal over the long term, and the alternate use of the money in our hands in the near term. In our case, we felt the business climate would be harsh in the coming years and it may cause issues for the purchaser going forward. Most importantly however, we had an immediate use for the cash as an investment in a project whose fortunes we would control. These assumptions made a cash deal the best scenario for us at the time.

Romulous isn't against financing the sale of a business: it's a decision that has to be made on a case-by-case basis, because each business sale is different.

"Had we been able to calculate that the 'custodian' purchaser was the best investment over the term of the deal, and had we simply been making a sale based on returns without a future project in the can and ready to go, it may have been less a risk to strike the terms that way. In this case, the purchaser would have had to provide safety and return beyond what we could — a straight up investment decision. However, the facts being what they were at the time, we would not have agreed to anything other than cash. In summary, when you accept a structure that has the purchaser retain possession of the purchase price in any form, you go from vendor to investor at the stroke of a pen. The question is always: Would I have invested in this firm under different conditions?

Negotiating the Deal

For Romulous, putting together the deal was easier because he was firm on the need for a lump sum payment. He says:

Striking a deal is the easy part — it's just talk. The hard part is the structure where both parties attempt to bend the agreed terms to their favor. In our case, we knew going in that we would want cash and we made that clear from the get go so there would be no misunderstanding. Thus, it became a 'take it or leave it' proposition for the purchasers.

If you're running into trouble negotiating a lump sum, Bradshaw suggests seeking out ways to make it easier for the buyer to find his own financing:

When negotiating a lump sum payment, a key consideration is what sources of financing are available to a potential buyer? How can I assist the buyer in obtaining financing — if I have a conversation with my banker, what does he estimate as the amount who would finance for my enterprise?

Negotiating a deal dependent on financing is more of a balancing act. Bradshaw says:

When negotiating financing, it is key to ensure alignment between the interests and motivations of the buyer and seller. Both at transfer of operating control and during the payback period. Both parties need to of course have appropriate legal and practical protection (an experienced legal adviser is important here). The terms of the agreement should be clear and understood by both parties. I would also recommend some independent, fairly quick means of resolving any disagreements as to the interpretation of the financing agreement (perhaps arbitration).

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