Finding the right buyer for your business can be challenging, and the sales agreement can take several forms. One option is selling a business with installment payments. Before making a decision, you need to understand the pros and cons of an installment sale of an entire business.
To illustrate, let’s assume that Julie is the majority owner of Premier Sporting Goods, an online business that sells equipment for each major sport.
What is an Installment Business Sale?
An installment sale means that the buyer’s cash payments are spread over time, and the purchaser does not pay the entire amount at closing. The seller chooses to finance the purchase by delaying full payment and receiving cash over time.
If you’re willing to provide financing and accept payments over time, you’ll attract more buyers. If bank financing isn’t needed, you can entice the buyer to close a sale, and negotiate a higher price.
There are risks and rewards for a seller, however, and a business broker can help you make an informed decision.
Factors That Impact the Sale Agreement
Here are some factors that a seller must consider before finalizing a sale agreement:
If your business is structured as a partnership, or includes multiple owners in an LLC, you must get approval from each partner or owner. Julie owns 70% of Premier Sporting Goods, and has two partners who own the remaining 30%. The three agree on an installment sale approach.
Terms of the Agreement
A longer term increases the risk of collectability. Premier’s business is heavily impacted by changes in technology, and supply chain issues can create inventory shortages. Julie wants to limit the term of the agreement to three years.
Down Payment Required
Julie wants a reasonable down payment, so that the buyer has a financial incentive to complete the agreement and manage the business. Premier negotiates a 35% down payment, with the remaining 65% paid over three years.
Premier charges 6% interest on the outstanding loan balance, which generates interest income for the owners. Charging interest incentivizes the buyer to repay the principal balance as soon as possible.
Premier’s owners can earn additional payments, based on THE success of the business after the sale. The payments are based on products that existed at time of sale. If the buyer develops new lines of business after the sale, the revenue is not used to calculate the seller’s contingency payments.
The contingency payments are calculated based on units sold, and the total dollar amount of sales.
Finding the Right Buyer
The buyer must have the skills necessary to operate the business over the long-term. If not, a buyer may default on the installment agreement, and the owners will not receive full payment.
Has the owner managed a profitable business in the same industry? What is the buyer’s reputation among business peers? Can the buyer provide references to former business partners, or to someone who bought the buyer’s prior business?
A broker can help you find the right buyer. Brokers maintain a network of accountants, attorneys, and investors who work on business sales. They will also evaluate the experience level and track record of each potential buyer.
Financial Impact on the Seller
An installment sale affects the seller’s tax liability on the sale.
Since the payments are spread over a period of years, so is the seller’s capital gain tax liability. An installment sale also ensures that most or all of the capital gains are long- term, which may be taxed at a lower tax rate. Several variables can impact your tax liability.
Tax Rate Increase
You may pay a higher tax liability on capital gains recognized in later years due to a tax rate increase. Tax laws change frequently.
Tax Treatment by Asset
The IRS does not allow all assets to be sold and taxed using installment payments. For example, any capital gain on accounts receivable and inventory must be paid in the year of the sale. Intangible assets, such as goodwill, can be sold using an installment payment method.
Personal Finance and Money Management
Receiving payments over time also impacts the seller’s personal finances. Rather than investing a lump sum, your financial advisor must plan on cash proceeds received over time. To create a diversified portfolio, your financial advisor needs to know the timing of the payments.
If you have plans to buy a vacation home or make another large purchase, you’ll have to consider the payment schedule.