Why a Business Owner Should Review the Buyer’s Personal Financial Statement or Balance Sheet Before Starting Negotiations

Apr 9, 2024

In many ways, the purchase or sale of a privately held company is similar to playing a game of poker or chess.  Decisions made in haste without proper analysis can come back later to haunt a party with significant implications.

One simple activity by a seller and/or their professional intermediary early in the sale process when engaging with potential buyers can mitigate risk and future issues in negotiations & successful facilitation of the transaction to closing.   This activity is reviewing the buyer’s personal financial statement or balance sheet, if the buyer is a corporation.

Why is this review important and what will it tell?

The first item this review will convey is how much liquid capital the buyer has available to put into a transaction and for post acquisition needs including working capital and execution of desired improvements (e.g., a website upgrade, enhancement of staff talent, etc.).   More businesses fail because they are under capitalized than for any other reason.  Confirming the fuel is in place to run operations even in an unexpected storm (e.g., loss of a key customer, work stoppage by “Act of God or Government”, etc.) is important if continued employment of the existing team and service of customers is a transactional objective of the ownership transitioning out of leadership.

A lower than needed amount of liquid capital is not a death sentence for a buyer interested in acquiring a specific company.  It simply means that the seller and their business broker may need to problem solve to get the deal to a “win-win” situation for the parties in terms of risk allocation.  Many lenders using SBA (Small Business Administration) backed loan products to facilitate the purchase of businesses and real estate have the ability to finance 90% or more of a deal if a seller is willing to subordinate a seller loan as part of the acquisition package.

As an example, I have seen a buyer put in $250,000, a seller finance $500,000, and the bank finance $4,500,000 in a business sale deal.   In this situation, the retiring business owner received $4,750,000 at closing or 90% of the sale price in cash.  Yes, there was risk on a half million dollars, but mitigating the transactional risk to 10% was a satisfactory outcome in this situation.

It is also common for lenders to incorporate working capital or a line of credit in loan proposals.  They do this as a benefit to their borrower client and also to mitigate their own loan risk.   I recommend buyers take every penny of line of credit offered by a lender.  You can never have too many resources.  It is also harder to get loan approval on a rainy day as an entrepreneur than one when the sun is shining and flowers are blooming.

Short of capital to complete a desired acquisition, a buyer, seller, and the business broker facilitating the transaction should move their eyes down the personal financial statement to the line for retirement accounts.   Many buyers do not know that utilizing companies like Guidant Financial ( https://www.guidantfinancial.com/) they can deploy retirement assets to obtain needed capital.  Conceptually the use of these funds is similar to investing in a privately held company versus a publicly traded one.  If the investment return is positive, the retirement account will grow no different than if an investment had been made in Amazon, Microsoft, or Tesla.  If an introduction to Guidant Financial is desired, IBA is happy to introduce you to someone at the firm who can educate you on the process associated with using that asset in a business acquisition.

The next element a business owner should review is a buyer’s net worth.  Net worth is often described as signature power.  Simply put, a person’s net worth is the positive asset base backing up their signature.  Calculating net worth involves subtracting liabilities from assets.  For many people, the most significant asset they own is their home.  The liability associated with a home is the mortgage, or the amount still owed on the real estate.  If a person had major assets of $250,000 in cash, $500,000 in retirement accounts,  and a home worth $1,000,000 on which they owed $500,000 and no other debt, their net worth would be $1.25 million. Calculating the net worth of a company is done the same way.   Companies go bankrupt just like people.  The fact that an entity is a corporation is no indication that it is an entity on firm footing.  Most people shopped at Kmart during their lives.  Today the company is a light shadow of its former self.  Many people who invested in or leased property to Kmart regret the decision today.  https://startupstumbles.com/what-happened-to-kmart/  Could some decisions have been better made with more information and enhanced assessment of the entity before engaging with the company, I suspect that is true.

It is my preference to only play games that I have an opportunity to win.  That includes facilitating the sale of privately held companies and family businesses.  An assessment of a potential buyer’s net worth allows me to mentally play out two elements commonly necessary to complete a business sale transaction. The first is determining in communication with my client, what they will need in collateral to finance a portion of their business.  Some clients are satisfied with a subordinate lien against the assets of the business they are selling to a primary lender and a personal guarantee (Similar to what you provide a bank to get a credit card) from the buyer.  Others want more tangible assets (e.g., real estate) collateralizing a loan and/or a co-signer to supplement the signature power of a buyer.  What is necessary and acceptable depends on the buyer, seller, and business.  A seller may be unwilling to finance a portion of a business sale for a fresh college graduate with no entrepreneurial experience who lives in an apartment with no appreciable assets, even if they can get a SBA loan. The same individual may be happy to finance the same individual if their last name is Gates and Melinda Gates cosigns the loan.  The point being, there is no black & white answers in this situation.  Each situation needs to be separately assessed.

Beyond seller financing considerations, most deals have a third party involved who will also need to assess and approve the buyer’s personal financial statement or balance sheet for the transaction to be successfully completed.  That individual is the landlord of the business.  In most situations, this party does not care whether the business sale is completed, in fact they may prefer the status quo over a transition of ownership of the business.  The stronger the buyer’s signature the more likely they will be approved as a successor in control of a leasehold interest.  Most business sellers do not wish to guarantee leases for buyers, so they will seek to be dropped from the lease at time of assignment.  This issue has the real potential to be a deal killer if a party is not brought forward who will pass scrutiny of the landlord. Broker Note: This is one reason it is recommended to engage a business broker who is also a licensed real estate professional to facilitate a business sale: https://ibainc.com/blog/gregory-kovsky/six-reasons-it-is-prudent-to-engage-a-business-brokerage-firm-with-licensed-real-estate-professionals-to-sell-your-business/   Most banks financing business acquisitions want a term of the lease to match the term of the loan, so if a business is committing to pay $100,000 of rent a year for ten years, or a million dollars over a decade, the landlord will want to ensure they are paid, even if the business stumbles or the owner gets hit by a bus.  A buyer with a weak personal financial statement can have their signature power be the Achilles heel that kills a deal at the lease assignment stage.  It can be very frustrating for both the seller and their business broker if this happens and it could have been avoided by selecting a different buyer with a stronger personal financial statement.

Rounders is one of my favorite movies.  It has many great lines and situations that apply to the world of business brokerage.  In this movie about poker, the players need the capital to sit at the high stakes’ tables, the reserves necessary to finish what they started, and the ability to competitively rise to the top of the mountain.  At the end of Rounders, the lead character, played by Matt Damon, is headed to Las Vegas with three stacks of high society to play in the World Series of Poker.  The business brokerage parallel is a buyer sitting at the table and trying to acquire a company.  They, like this character, will need to have the skill & resources to get the job done.  They will also need an attorney (Note the attorney line, one of my favorite ones in the movie from this clip https://youtu.be/CZ59wZwtfH0?si=ULmHkQAJlglIZCvI)  But, that is a story for another blog.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, legal, and accounting communities on subjects relevant to the purchase & sale of privately held companies and family-owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.