FINANCING AN ACCOUNTING PRACTICE BY ACCOUNTING PRACTICE SALES IT IS IMPORTANT FROM THE BEGINNING to recognize the way that purchasing a practice does not happen. The buyer does not take the full purchase price out of savings and write a check to the seller. If a buyer has that much money, he or she would not be buying himself/herself a job. DOWN PAYMENT Our hope is that the buyer can come up with a substantial down payment. That varies, of course, but owners often consider 20% to 50% to be adequate. Remember that the down payment is not the only cash the buyer will be investing in the business. He or she will need working capital to get the new business going and to pay bills until the receivables get up to a normal level and start to turn. So, sellers should not be so shocked by the thought that a buyer can manage only 20% down. Think back over the years about your clients and ask yourself how many of those clients could come up with that kind of money. The down payment accomplishes two important goals. First, it shifts a very significant amount of the risk to the buyer. To correctly understand investment risk, think of risk in terms of layers rather than in total. If a person were to buy a piece of real estate for $100,000, he or she might think the risk incurred is $100,000. More correctly, he or she is making 100 investments in the amount of $1,000 each. The first $1,000 invested carries a very significant risk. If the value of the investment declines by a mere 1%, he or she has lost that $1,000 in its entirety. On the other hand, the last $1,000 is not at risk at all. It is as safe as a U.S. Treasury bill. The real estate will not become entirely worthless. The second thing accomplished by the down payment is that it secures the buyer’s commitment to the purchase. Buyers will go to great lengths to avoid losing this substantial investment. Oftentimes, unsophisticated lenders (such as the seller) imagine that at the first sign of difficulty, the buyer will walk away from the practice and leave them holding the bag. Nothing like this is likely. The buyer might find that the practice does not meet all of his dreams or expectations. He might find that he has to work at it a lot more than he realized, but he has too much invested to walk away. Sophisticated lenders realize that if you have a buyer who can make a substantial down payment, you have eliminated the vast majority of the general public and are working with a rather unique individual. If this person additionally has a history of handling his credit in a responsible manner, evidenced by his credit report and the fact that he has accumulated a substantial net worth, then the lender knows his risk is minimal. SBA FINANCING While buyers do not normally have enough cash to pay sellers all cash at closing, it is still possible in many cases for sellers to get substantially all cash for their practices. The primary source of this cash is through U.S. Small Business Administration (SBA) financing. Normally, conventional financing is very difficult due to banks’ insistence on collateral lending. SBA, on the other hand, is willing to loan based primarily on the historical cash flow of the business, the buyer’s credit history, and the buyer’s experience. The first problem, however, is that it is harder to qualify the practice than it is to qualify the buyer. To qualify the practice, the cash flow from the practice must cover 125% of the total of the new owner’s salary and his debt payments. SELLER FINANCING From our experience, half or more of the practices do not have that much cash flow. Do not blame the buyer for this. If your practice is bigger than the minimal size and if your net cash flow is somewhere near 50% of gross revenues, then it will probably qualify. If historical cash flow is significantly less than 50% of cash flow, you need to face the fact that the profitability of your practice is not up to ideal and that your practice may not qualify for SBA financing. What we hope for in that case is that your cash flow will pay the owner’s salary and make debt service, or that your buyer has sufficient expertise and determination to fairly rapidly expand profitability. In these cases, seller financing should be considered. Besides the fact that seller financing might be the only practical way to get a practice sold, seller financing also carries a couple of benefits. For one, it is a fact of life that a practice can be sold for 10% to 15% more with seller financing than without. In addition, the seller receives additional advantages related to installment sale treatment for tax purposes and possibly a desirable rate of interest earned on the loan vs. CD rates. Besides these advantages, a seller-financed transaction avoids a great deal of time-consuming SBA process and allows deals to get done that otherwise would be impossible. Our goal is to sell a practice for all cash or cash equivalent. We do not believe the seller should be at risk for the buyer’s success. If the payment of the remaining purchase price is dependent on the buyer’s success in the practice, then the seller is still at risk. To avoid this, the practice can only be sold to qualified buyers whose net worth, credit history, and down payment are substantial enough so that the seller will be paid even if the buyer does not make the practice as much of a success as he or she has hoped. The experts at Accounting Practice Sales are here to help with all aspects of buying and selling accounting practices. To learn more, contact Trent Holmes at Accounting Practice Sales at (800) 397-0249 or trent@aps.net. 24 Nebraska CPA
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