Structuring Payments in a Business Purchase

Learn about the business buyer's payment options, such as installment or lump-sum payments.

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If you're considering buying a business, the thought has probably occurred to you: How exactly are you going to pay for it? Given the probable price tag, this isn't a situation where pulling out your credit card will likely help. Fortunately, the seller doesn't usually expect to collect the entire purchase price up front, as a lump sum. Nevertheless, this article will examine both how a lump-sum purchase works and how the more likely alternative, an installment sale, works.

Making a Lump Sum Purchase

If you have the cash, you can, of course, pay the whole amount at closing. Might there be good reasons to do this? One possibility is that the business is very attractive to you, but the seller insists on full payment. Another possibility is that the seller offers a worthwhile discount on the sale in exchange for full payment.

Under either of these scenarios, of course, you'll have to figure out how to come up with the cash to make it happen. If you already own a larger business and have accumulated a cash reserve, you're in a good position to use cash to buy a smaller business. Or, perhaps you've inherited a large sum, received a buyout or retirement payment from an employer, or can line up a business loan, home equity loan, gift or loan from family and friends, and so forth.

Making an Installment Purchase

The more common form of structuring payments in a business purchase is for you to make a down payment of perhaps 20% or 25% and then sign a promissory note agreeing to pay the balance to the seller over a number of years, in regular installments.

Although down payments are usually made in cash, some buyers have been known to substitute an asset or services for all or part of the down payment. For example, maybe you own a boat, a timeshare interest in a vacation condo in the Bahamas, or even a serviceable truck. As long as these items are not encumbered by debt, the seller might be happy to accept any of these as part of the down payment. Similarly, if you have home improvement or other skills, the seller might be interested in having you dedicate these to a project he or she needs help on.

As for the terms of the promissory note, you and the seller will specify these in your sales agreement. You'll need to have agreed upon a number of variables, such as the down payment amount, the interest rate you'll be charged (because you're essentially receiving a loan from the seller), the payment schedule and final payment date, what happens if you fail to make payments, and more.

As the buyer, be careful not to agree to an overly ambitious payment schedule, excessively high interest rate (your state's usury law may set an upper limit), or any other terms that will make the plan unworkable for you. For calculating the monthly payments based on the loan amount, loan term, and interest rate, use a handy online amortization calculator such as the one found at http://www.amortization-calc.com/.

For example, you'll probably be asked to pay the balance of the sales price by making equal monthly payments over the course of two or three years, or perhaps a bit longer. Try to avoid a shorter payoff period unless it's clear that your new business will produce sufficient profits to allow this.

Also, it's usually better to make a relatively low down payment -- around 10% rather than, say, 30%. The idea is to keep some cash in reserve for unexpected expenses in the early months of ownership (such as old bills that the seller neglected to mention) or to help ride out slow periods.

What about those old bills? Your purchase agreement should include a clause saying that the seller has agreed to pay them. But if the seller doesn't follow through, you can pay them yourself and deduct the amounts from your upcoming installment payments.

Hopefully, all will go well and you'll make the payments on schedule. If not, however, realize that your agreement will probably need to allow the seller a way to collect payment for the business by containing terms allowing the seller to either foreclose upon your business or collect from your personal assets.

For more information on all aspects of buying a business, including structuring the payment plan, negotiating reasonable terms, and more, see The Complete Guide to Buying a Business, by Attorney Fred S. Steingold (Nolo).

Of if you're ready to get a lawyer's help in planning or structuring a business purchase, you can check out profiles of business lawyers in your area in Nolo's Lawyer Directory.

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