Latest / The Buyer & Seller Podcast with Fexingo: Business Brokers, Exits, and Private Sales Explained / How Owner Financing Closed a Deal at a Higher Multiple
Transcript
- Lucas: So there's a story that's been making the rounds in the broker community, and it's about a commercial cleaning company that sold at eleven times EBITDA. Eleven times. For a janitorial business, that's not just a good number; that's an outlier. Luna: Eleven times for commercial cleaning? That's usually a six or seven times business at best. What was the secret sauce? Lucas: The seller agreed to finance thirty percent of the purchase price over five years. And that piece of paper — the seller note — is what got the buyer comfortable paying a premium. Luna: Before we dig into the numbers, if this episode is turning out to be useful to you, the way we keep this show ad-free is listener support. You can buy us a coffee at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small gesture that keeps these conversations going. Appreciate anyone who chips in. Luna: But back to the cleaning company. Why would a seller take on that kind of risk just to get a higher multiple? Isn't it all cash at close usually? Lucas: Usually, yes. But here's the thing: when a seller holds a note, they're essentially saying to the buyer, 'I'm confident this business will keep performing, so I'm willing to share the risk.' That signal alone is powerful. It tells the buyer that the owner isn't selling because the business is about to crater. Luna: So it's a signal of confidence. But how does that justify paying eleven times when the norm is closer to seven? Lucas: Right. The buyer is taking on less risk because the seller is sharing it. If the business doesn't hit its numbers, the seller doesn't get paid the full amount. So the buyer can afford to pay more upfront because the downside is partially cushioned. In this case, the thirty percent seller note effectively reduced the buyer's out-of-pocket risk by that amount. Luna: But isn't that a bit like the seller paying themselves? If the multiple is eleven times, but the seller is financing a chunk, the actual cash at close is lower. Are they really better off? Lucas: It depends. In this deal, the seller got a note with an interest rate of eight percent, which is above what they'd get on a ten-year Treasury. Plus, they're deferring some capital gains taxes over the life of the note. So the effective return can be higher than taking all cash and reinvesting it elsewhere. Luna: So there's a tax angle too. That's something sellers don't always weigh when they're fixated on maximizing the headline number. Lucas: Exactly. And there's a subtle psychological thing. When a seller holds paper, they're often more motivated to help the buyer succeed post-close. They might stick around as a consultant or make introductions to key clients. That can make the transition smoother and actually improve the odds the earnout, if there is one, gets paid. Luna: But what if the buyer runs the business into the ground? The seller could end up with nothing beyond the initial down payment. That's a real risk. Lucas: Absolutely. That's why the structure matters. In a typical seller note, the seller is in a subordinated position, meaning they get paid only after senior debt, like a bank loan, is serviced. If the business tanks, the seller is last in line. So sellers need to do their own due diligence on the buyer's credibility and their plan for the business. Luna: So what protections can a seller negotiate? I've heard of personal guarantees, but that seems to defeat the purpose of asset protection. Lucas: Personal guarantees are tough to get, but sellers can ask for a blanket lien on the business assets, or they can structure the note so that the buyer has to maintain a certain debt-service coverage ratio. They can also put covenants in the agreement that limit the buyer from making big capital changes without the seller's approval. Luna: That sounds like a lot of ongoing oversight. It's not a clean break for the seller, which a lot of them want. Lucas: And that's the trade-off. Some sellers just want to walk away with a check and never look back. But for others, especially those who believe in the business's long-term prospects, holding a note can be a way to get a better overall return and also a higher sale price. Luna: Now, I've also heard that seller financing can actually lower the multiple in some cases. Is that true? Lucas: It can if it's not structured well. For example, if the seller is financing a huge portion, like eighty percent, and the note is unsecured, buyers might see that as a red flag. They might wonder, 'Why is the seller so eager to finance? Is the business that weak?' So there's a sweet spot. Typically, seller notes range from ten to forty percent of the purchase price. Beyond that, it can signal distress. Luna: So it's a delicate balance. On the one hand, seller financing reduces buyer risk; on the other, too much of it makes the seller look desperate. Lucas: Right. And the terms matter just as much as the amount. The interest rate, the amortization schedule, whether there's a balloon payment, and the subordination clause all play a role. In the cleaning company deal, the note was amortized over five years with a balloon at the end, which is common. That gave the buyer lower monthly payments but a lump sum due at the end, which the buyer plans to refinance. Luna: That balloon can be risky for the buyer if they can't refinance. And for the seller, if the buyer defaults, they get the business back, but it might be in worse shape than when they sold it. Lucas: Exactly. But in this case, the seller did their homework. They vetted the buyer's financials, they had a strong management team in place, and they even retained a small consulting stake to keep an eye on things. So the risk was mitigated to a point they were comfortable with. Luna: So, for a seller listening, what's the takeaway? When should you consider seller financing? Lucas: If you're selling to a financial buyer like a private equity group, they often have access to cheap senior debt, so they might not need seller financing. But if you're selling to an individual or a small strategic buyer, seller financing can be the bridge that gets the deal done. It can also be a way to get a higher multiple if the buyer is risk-averse. Luna: And for buyers, what should you watch out for? Lucas: First, make sure you understand the seller's motivation. If they're financing, they're confident, but you still need to do your own due diligence. Second, negotiate the terms. Don't just accept the seller's first draft. You want a reasonable interest rate, a repayment schedule that matches your cash flow, and no prepayment penalties if you want to pay it off early. Third, consider the tax implications for the seller. Sometimes you can structure the deal to benefit both sides. Luna: It sounds like seller financing is a tool that, when used wisely, can create a win-win. But it's not for everyone. Lucas: Absolutely. It's a negotiation tool, not a silver bullet. The key is to understand the risks and structures, and to work with an experienced broker or M&A advisor who's seen these deals play out. In the right situation, seller financing can do exactly what it did for that cleaning company: push the multiple from seven to eleven. Luna: That's a huge difference. For a seller, that could mean hundreds of thousands of dollars more in their pocket over time. Lucas: And for a buyer, it can mean acquiring a business they otherwise couldn't afford. So it's worth exploring, but with your eyes open. Luna: Thanks for walking us through that, Lucas. I feel like I understand the mechanics a lot better now. Lucas: Glad to help. If you're thinking about selling your business, it's worth asking your broker about seller financing as an option. It might just be the difference between a good deal and a great one.