Income producing assets are a great addition to your portfolio. The only problem is that they’re often prohibitively expensive to acquire. I don’t know about you, but I certainly don’t have £500,000 lying around to acquire ownership rights over a successful business. But what if you didn’t need the money right now? What if you could use the forecast profits of the company as collateral and get a loan for the money?
Most banks aren’t generally too happy to lend money like this, as the profits of the business aren’t guaranteed and unless you’ve got a strong track record in the industry, you’re a bit of an unknown quantity as an owner. Despite this, there is another model of financing which can help you acquire the business without needing the entirety of the payment upfront.
Consider this example. A local engineering company is selling for £500,000. By carrying out your due diligence, you’ve spoken to the owners, reviewed the financial records, verified future orders, and believe that the company has room for further growth with the right strategy and enough time. You plan to buy the business, work hard for three or four years to grow it and then bring a manager in to take over from you.
There’s only one problem. You don’t have enough cash to buy the business, and the bank won’t lend it to you either. You’ve never tried capital raising from investors before, but regardless, you want to own the business outright, without the financial obligations to other shareholders.
Introducing Seller Financing
Deciding not to give in, you approach the business owner with a deal. You offer to pay £525,000, rather than £500,000, and over ten years, instead of immediately. You also offer to put £50,000 down today as a show of good faith, and will then be paying £47,500 a year for the next ten years.
A deal like this is advantageous for both parties. The seller is essentially lending you the funds but is receiving an extra £25,000 for doing so. On the flip side, you only have to have £50,000 (less than 10% of the value of the business) in cash, and then the business will pay for itself. If, for whatever reason you break the terms of the agreement, the seller can take back the business as collateral.
Of course, this all presumes that the business can consistently generate at least £47,500, after tax, in revenue every year, on top of paying enough money for you to draw a salary (unless you intend to work for free for ten years!). Even an established business will have fluctuations in revenue and if a recession hits, you might find yourself making some tough decisions to keep paying that £47,500 every year.
Conclusion
If proper due diligence is carried out on the business, seller financing can be a great option to acquire an asset. The seller can withdraw a steady income and charge a premium for having to wait to get the entire value of their business. As a buyer, you can acquire the asset without needing hundreds of thousands of pounds in cash.
Obviously, each deal will be structured slightly differently. The seller might want a bigger down payment, or the right to modify the repayment rate, or might even request alternative collateral to simply reclaiming the business. After all, if you asset stripped a company and ran it into the ground, it wouldn’t be worth much if you then failed to make the repayments.
Lacking cash can be an obstacle to growing wealth, but it doesn’t have to be insurmountable if you’re willing to be creative in the way you approach deal-making. Seller financing is just one of the many ways to purchase an asset and start building your portfolio of income producing assets.