As you move forward with the sale of your business, it’s important to understand how sales are financed and how the proceeds are taxed. Each type of financing has a different approach for funding and paying off small business purchases, and each has its financial benefit to either the buyer or seller. Therefore, the purchase terms of the final sale are a point of negotiation.
Before agreeing to the payment approach and price allocation, it is important that you consult with those who are trained and up-to-date on the legal, financial and tax implications of each. Find out how you can qualify for certain tax deferrals, as well as how you can allocate the purchase price among IRS-defined asset classes and avoid taxation at the highest rates.
The following are general descriptions on the different payment approaches and how each approach may affect your particular sale.
Cash Payoff at Closing
Although this is quite unlikely, an all-cash payment at closing eliminates any concerns about the buyer’s ability to make after-closing payments. Yet, an all-cash payoff has the potential to move you into a higher tax bracket. You’ll receive all proceeds as revenue during a single tax year. Plus, it also limits the buyer pool to those with cash resources or the ability to obtain cash through third-party loans. Research shows cash-at-closing sales generally result in lower selling prices.
Third-party financing allows the buyer to obtain the required down payment or to pay for the business at closing. Bank loans are usually difficult to find and time-consuming to obtain. If during pre-screening a buyer indicates need for a third-party loan, request a prequalification letter from a lender who is prepared to provide the funding. And, in advance of the sale, contact your bank or SBA office to learn if and how the purchase of your business sale might qualify for an SBA loan.
Home Equity Loan
Homeowners can self-finance the purchase of a business by using the equity in their residences through a second mortgage. If the buyer requires a home equity loan to fund the closing day down payment, and if you provide a seller-financed loan for all or some of the outstanding balance, don’t accept the buyer’s home as loan security. In doing this, you would have a subordinated position should you ever need to call on the asset.
Seller Financed Loan
Accepting deferred payments through a seller-financed loan will attract many more buyers, while at the same time speed up the purchase transaction. It will also convey faith in the future of your business, and as a result, tend to obtain a higher purchase price. Seller financed deals also spread sales proceeds over multiple years, which may allow you to avoid taxation at higher rates.
By signing a secured promissory note, the buyer gives you legal right to valuable assets, which is collateral that you can seize as recourse if loan repayment terms are not met. Beware of collateral in which you take a subordinated or secondary position. Also, beware of accepting business assets as collateral, as they can become devalued before you seize them. The business itself is often collateral for the seller loan, which means the seller gets the business back if the buyer defaults.
Buy requesting a personal guarantee as loan security (and buyer’s spouse’s personal guarantee as well, if they live in a community property state) you obtain a personal repayment promise that allows you to pursue personal assets as recourse, if necessary.
Once again, before agreeing to the purchase terms of the final sale, it is important that you consult with trained professionals, such as your attorney or accountant, who are up-to-date on the latest legal, financial and tax implications of each.
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