A business sale can be an exciting time for sellers.
If your business has been on the market for months or even years, the sudden arrival of a buyer can be seem like a godsend. But does the buyer have the financial capacity to see the deal through to its completion? Maybe . . . and maybe not. The only way to answer that question definitively is through due diligence.
Seller due diligence evaluates a prospective buyers ability to successfully purchase and operate the business. There is a lot of ground that needs to be covered in due diligence. Everything from the buyer's motivation to his industry reputation needs to be verified before the seller commits to a Letter of Intent.
However, most of the seller's due diligence requirements focus on the buyer's financial capacity. Many prospective buyers simply lack the resources to purchase an established small to medium sized business. When it's time to sell your company, you need to assess not only the buyer's upfront capital position, but also the resources that are available to operate the business on a go-forward basis. Here are some of the specific financial issues that have to be resolved through your due diligence efforts.
- Down payment capacity. The quickest way to separate the window shoppers from the real buyers is to evaluate their down payment capacity. Most lenders won't even consider a business buyer unless he has a down payment of 30% or more. If the buyer insists that he can raise the down payment through a lender or business grant, invite him to come back once he has a firm commitment and quickly move on to the next potential buyer.
- Earnout capacity. In some industries, it's common for sellers to finance part of the purchase price. In addition to evaluating the individual's down payment capacity, you will also need to evaluate his ability to make payments after the closing. Look for a solid business plan and cash reserves to cover the unexpected costs that will almost certainly arise during his critical first year of ownership.
- Collateralization. A collateral position in the business alone may not be enough to secure your financing position. In some cases, it might also be necessary to take collateral in the form of the buyer's personal assets. But before you agree to the deal, conduct a thorough appraisal of any personal assets that will be provided as collateral.
- Credit history. It doesn't matter whether you are financing part of the purchase or not – a credit check is a standard tool for evaluating the buyer's credit worthiness and financial capacity. Work with your attorney to design a release form authorizing you to perform a credit check on the buyer before you sign a Letter of Intent.