Why won't the seller finance the
sale?
Whoa boy! Half way through 2000 and we still have confusion!
As you may or may not know, the tax code was changed late in 1999 at a midnight hour.
In the past, most sellers held the first mortgage when they sold their business. They would accept anywhere from 10% to 50% cash down, and hold the remainder for 1 to 10 years. This accomplished several things. It made a business financable. If someone could buy it with a smaller amount of cash required as downpayment, obviously, the larger the pool of buyers. The more buyers, the higher the sales price.
It also supplied the seller with a larger return on his money over time. Most seller mortgages were written at a higher yearly interest rate than they would earn on a CD or money market account.
It also deferred capitol gains taxes over the same period that the seller received payments. It worked well all the way around for everyone.
With sales that took place at the end of 1999 (ignorance was no excuse at the closing table. None of us saw it coming...) and now in 2000, the seller is subject to capitol gains taxes on the full amount of the sales regardless of the amount actually received at closing! (Capitol gains is applied to the profit portion of the sales price after the basis, depreciation, etc. seek competent legal tax counsel for detailed explanation.)
So, hypothetically, a seller has had his business for ten years and depreciated almost everything down to zero worth. He now sells the business for $200,000. If the basis is zero, he could owe 28% (your actual figures may be more) or $56,000.
Hmmm and you wanted to offer 30% down to seller first mortgage?
Wait, there is more!
There will be cost of sales (broker, attorney and accountant. Easily another 15-20%).
- Then the seller still owes the buyer for pre-paids
- next years taxes; funds in escrow for 30 days after the closing just in case something comes up
- the seller has the liability still of being on the lease for 12-24 months while the new buyer proves himself
- franchise transfer fee
- oh and some landlords or management companies want a 'lease transfer fee' from the seller
So, what has this done to business prices? The prices have come down for 2000. But fewer sellers are able to finance them. SBA loans are being applied for at record rates. Not only must the business qualify to support the debt service, but the buyer must qualify to support the collateralization of the loan. (I know, if the business is so good, why aren't the assets enough collateral? If the asset value were equal to the cost of the business, wouldn't the seller just auction off the assets and get out in ten days?)
When I meet with a seller not aware of the tax changes, I advise them to speak with their tax attorney or accountant first. A quick sale at a lower cash price is worth more in many cases than a higher price that the seller may have to finance. In some instances, I have seen business shut their doors and auction off assets.
So, if you are looking at buying a business today, it's just like buying an automobile or a house. Get to a bank and get pre-approved. Not pre-qualified, but pre-approved. Walk into a brokers office armed with that and say "I'm ready, willing and able. I'm in the market to buy now."
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12/19/00
The tax act of December 1999 has been reversed retroactive to December 18, 1999. My opinion is that it will bring the asking/selling prices of businesses back up to where they were. 2000 saw some of the lowest sales prices ever. The down side is, that sellers now require the same background investigation and collateral that a bank does. The business is enough collateral to support the loan with the seller operating it as he has done in the past. With you at the helm, the seller has no control over the changes you wish to make. Fight it all you want, but the serious buyers are the ones getting the businesses that are good and for sale...
As a state licensed real estate and state licenses business broker I am not authorized by the IRS or any state or local agency to offer any tax advice. Accept advice only from a competent tax attorney or accountant that specializes in business taxation.
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