Comment on can seller boost multiple by financing the deal July 22, 2024
KEN KIRSCHENBAUM, ESQ
ALARM - SECURITY INDUSTRY LEGAL EMAIL NEWSLETTER / THE ALARM EXCHANGE
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Comment on can seller boost multiple by financing the deal
July 22, 2024
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Comment on can seller boost multiple by financing the deal from article on July 9, 2024
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Ken,
Interesting post titled “Can seller boost multiple by financing the deal” on July 9, 2024.
I agree with a lot of what you say but I want to point out a few things:
First, readers should keep in mind that multiples are an expression of value, not a determining factor. This means that a group of accounts has a price, and, to keep things simple, we express that price as a multiple of RMR. A company with $25,000 of RMR that sells for $1 million would be selling for a multiple of 40X. If it sold for $750,000 the multiple would be 30X. Informed buyers determine the value of the account base first, then they determine the multiple. When I prepare valuations for divorces, trusts, partner disputes, buyouts, etc… I determine the value of the company first, then I divide the amount by the RMR amount to arrive at a multiple. I do a one hour presentation on the factors that enter into the value of an account base. All of the things that you mention are factors and there are many others.
You are correct that seller financing usually results in a higher price. You are also correct that it adds complications to a transaction. While an experienced attorney can help a Seller (and even a Buyer) negotiate the hazards of seller financing, many sellers fail to involve an attorney to save a few bucks. This is the classic definition of “penny wise and pound foolish.” When a Seller finances all, or part, of a transaction, they become a lender. Shakespeare was somewhat correct, he should have said “Never a Lender or Borrower be – unless you have a good lawyer.” Interest rates have two components 1. Risk free rate of return – what the note holder expects to earn for essentially “investing” their money in the note, and 2. Risk component – what the note holder deems necessary to compensate themself for the risk of not getting paid back. The second is fairly easy for a lender like Citibank to compute – if 2% of their loans are charged off, their risk is around 2%. The problem with a seller note is that, if it isn’t paid back, the risk factor is 100%.
You are correct that the IRS requires seller financed transactions to have an interest rate. Not only does the IRS require that interest be charged on the Note, it requires that the interest be “market” interest. I am not going to get into the details here, but if your tax advisor isn’t able to quickly define this, find one who does. The IRS can, and will, come in after the fact and “impute” interest. This can change the entire deal.
You are also correct that a seller financed transaction can be considered an Installment Sale for tax purposes, allowing the Seller to pay tax over time. The downside to this is that if tax rates go up, the Seller could find themself paying more taxes over time.
The other hazard with seller financed transactions is that they give the Buyer a lot of leverage. I have been called upon as an expert in several cases in which issues arose after the Closing and the Buyer quit making payments on the note. Accusations fly, memories become convenient, situations are misinterpreted, and lawyers make money. It’s one thing to lose a 10% holdback, it is another thing to enter into a five year battle over a 90% note.
My advice for a Seller who is considering financing a sale is to get a good attorney who can advise you. If you still want to move forward, call us to help you structure the transaction and the taxes.
Mitch Reitman
817 698 9999 XT 101
Reitman Consulting Group
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Response
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You are certainly correct by pointing out the risk factor to the seller for financing the deal. It surely is 100% of the loan if no payments are made. Although it would be indeed rare for a buyer of alarm accounts to not make payment, it could happen and has happened. As a United States Bankruptcy Trustee for as long as I’ve been representing the alarm industry I’ve seen plenty of loans, and debt, go unpaid. You’d be surprised how often I see creditors with the same last name as the debtor; family members. Also I’ve had a good number of debtors file who are owed money on the sale of their business and testify that the debt was uncollectible, usually because the business failed after the sale and the buyer had no money.
A seller may be “pushed” even “compelled” to provide financing on a deal. It would have to a deal that was difficult to make, fairly undesirable for a buyer and the only buyer willing to take a shot was one who had little to lose if the venture failed. I’ve see a few alarm company sellers figure out they may as well ride out the existing contracts rather than take a haircut on a sale of the accounts.
All in all I think most sellers prefer getting paid at the closing. Deferring payment pending a guarantee period is enough discount in their mind.
Mitch and Shakespeare were took kind when calling someone acting as their own lawyer a fool. That’s because that saying is intended to mean a lawyer who acts as his own lawyer has a fool for a client. An alarm guy who acts as his own lawyer is an idiot. And don’t look in the mirror and tell yourself that it doesn’t apply to you because you’ve done deals without a lawyer and they worked out fine. Even a broken clock is right twice a day.
What is probably scarier is a seller with no lawyer dealing with a buyer with no lawyer. I’d be curious how they figured out how to transfer title to assets, assuming they bothered. I suppose there could be something worse than no lawyer; a lawyer who doesn’t know the alarm industry [or doesn’t know the law], in which case you’re getting poor advice, likely poor outcome and paying for it too.
Seller financing involves a lot more than the alarm industry, Debtor-creditor law is complex; promissory note and security agreement drafting takes skill and knowing how to protect your collateral takes experience. Collecting from a non-paying debtors is even more challenging.
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