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Seller Financing Issues When Selling Your Small Business

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Have you ever considered offering seller financing to attract more buyers for your business? It can be a game-changer, opening the door to a wider pool of potential purchasers while helping you secure a higher price. However, seller financing is not without its challenges, and navigating these challenges will help protect your financial interests.

Seller financing—where the seller acts as the lender—is increasingly common in small business sales, particularly when traditional financing options are limited. While this arrangement can provide flexibility and competitive advantages, it also introduces unique risks and responsibilities. Understanding these issues can help you decide whether seller financing is the right choice for you and your business.

What Is Seller Financing?

Seller financing allows a buyer to purchase your business with a down payment, while you finance the remaining balance over a set period. This arrangement often includes a promissory note outlining repayment terms, interest rates, collateral, and default conditions.

Why Do Business Owners Consider Seller Financing?

  • Attract More Buyers: Offering financing can make your business more appealing to buyers who lack the upfront capital.
  • Command a Higher Sale Price: Buyers are often willing to pay a premium for the flexibility of seller financing.
  • Faster Sale Process: With fewer barriers to entry, deals can close more quickly.

Common Seller Financing Terms

Typical seller financing arrangements require:

  • A down payment (usually 10%-30% of the purchase price).
  • Repayment terms spanning 3-7 years.
  • Interest rates slightly higher than bank loans to compensate for the seller’s risk.
  • Collateral consisting of business assets

The Risks of Seller Financing

While seller financing offers significant advantages, it also exposes you to financial and legal risks. A well-structured agreement can help mitigate these concerns.

Risk of Buyer Default

One of the greatest risks is the possibility of the buyer defaulting on payments. This could leave you with an unpaid balance and, potentially, a repossessed business to manage.

Impact on Your Retirement or Future Plans

If you’re relying on proceeds from the sale to fund your retirement or another venture, delayed or missed payments could disrupt your plans.

Legal Complexities

Without clear legal terms, disputes over payment schedules, interest rates, or collateral could arise. Proper documentation is essential to safeguard your rights.

Protecting Yourself When Offering Seller Financing

When offering seller financing in a business acquisition, there are a couple of steps you should take to protect yourself from potential risks. 

The first step is conducting thorough due diligence on potential buyers. This involves reviewing their financial history, creditworthiness, and business experience to ensure they have the capability to meet repayment obligations. 

Additionally, requiring collateral—such as business assets or personal guarantees—can provide security and give you recourse in the event of a default. 

Working with a lawyer to draft a comprehensive agreement is critical to help you clearly outline repayment terms, interest rates, penalties for default, and collateral requirements to ensure all parties are appropriately responsible and protected. 

Lastly, understanding the tax implications of seller financing can help you prevent a surprise tax bill in the future. While it may offer benefits, such as spreading capital gains over several years, it can also introduce complexities related to immediate income recognition on depreciation recapture and “hot assets” (like inventory, accounts receivable, and others). 

We’re Here to Help

Wilson Ratledge business attorneys can help you navigate these issues,  safeguard your interests and set the stage for a successful transaction.

Whether you’re preparing to sell your business or need assistance structuring a financing arrangement, our team is here to guide you every step of the way. If you’re ready to take the next step, contact us today to discuss your goals.

NC Supreme Court Sets Standard for Extended Benefits

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On December 13, 2024, the North Carolina Supreme Court filed its long-awaited decision in Sturdivant v. NC Dept of Public Safety, providing what should be the final word on the standard to be used in cases involving claims for Extended Compensation beyond the 500 week cap provided by N.C. Gen. Stat. § 97-29.  The decision is a vindication of the arguments advanced by the defense since the start of the litigation in these matters – that the term “total loss of wage-earning capacity” is different from the analysis of temporary total disability.

In Friday’s decision, the Supreme Court says the Legislature’s 2023 “clarification” that the term “total loss of wage-earning capacity” means the complete elimination of the capacity to earn any wages was really unnecessary, since the plain meaning of N.C. Gen. Stat. § 97-29 was clear when enacted in 2011:  “In sum, when the Industrial Commission interpreted the phrase ‘total loss of wage-earning capacity,’ it did so correctly.  The Commission properly concluded that the phrase means an employee’s ‘total loss of the ability to earn wages in any employment.’”  As a result, the Supreme Court rejected the Court of Appeals’ interpretation of the phrase “total loss of wage-earning capacity” and affirmed the denial of extended compensation to Plaintiff.

Read the full Order here.

With this decision, claims for Extended Compensation beyond the 500th week should be reserved for the extraordinary situation in which the injured worker’s capacity to earn wages is completely eliminated.  The ability to earn any wages whatsoever, in any capacity, should be a bar to Extended Compensation.

The Importance of Due Diligence in Mergers and Acquisitions

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We have written before about mergers and acquisitions and potential reasons to consider in your growth or exit strategies, and generally, what the process entails.  Whether you are a target or acquiring company, due diligence is a critical element of any transaction. In this post, we discuss what you need to know about due diligence in mergers and acquisitions, including what it is, why it matters, and how it helps set your company up for success.

What Does Due Diligence Mean in Mergers and Acquisitions?

Due diligence in mergers and acquisitions is a comprehensive analysis of the target company’s books, records, contracts, financial statements, tax returns, corporate culture, intellectual property, real property, equipment, in order for the acquirer to satisfy itself that the transaction and post-closing integrations will result in the benefits anticipated when negotiating the letter of intent. The official process begins with signing a confidentiality agreement and a letter of intent. Typically, the buyer conducts due diligence with the help of internal personnel and external advisors such as business lawyers, tax attorneys, financial professionals, auditing firms, asset appraisers, cybersecurity analysts, and other industry consultants. 

Five Key Reasons Due Diligence Matters in Mergers and Acquisitions

Companies should conduct due diligence in mergers and acquisitions with the following goals in mind:

1. Understanding the Target Company

If you’re considering merging or acquiring a company, you already know something about it. However, due diligence lets you peek behind the curtain for a more in-depth look. You can analyze everything from management structure and strategic goals to revenue models and customer contracts. 

2. Mitigating Risks and Identifying Opportunities

As you look more closely at an organization, you will learn more about its selling points and drawbacks. On the upside, you may discover additional synergies, favorable business prospects, and valuable cost-cutting opportunities. On the downside, you may uncover environmental problems, labor law violations, or pending litigation. 

3. Complying With Laws and Regulations

Due diligence can alert you to financial, regulatory, and legal compliance issues prior to a merger or acquisition. You may spot red flags, such as government investigations (including tax or other regulatory audits) or intellectual property issues. Verifying compliance beforehand helps save time, resources, and reputational damage later.

4. Determining Valuation Adjustments

Evaluating financial statements, cash flow, revenue streams, and historical metrics helps you identify hidden issues that may affect the valuation.  Specific issues revealed during due diligence and be addressed by negotiating one or more of purchase price adjustments, escrows, additional warranties, and specific indemnity provisions.

5.  Integration Planning 

The information gathered during due diligence can be used to develop a successful integration plan. This includes identifying potential synergies, streamlining operations, and managing cultural differences.

Reverse Due Diligence: A Seller’s Perspective

While traditionally associated with buyers, sellers can also benefit from performing due diligence on themselves, known as “reverse due diligence.” This proactive approach helps sellers:

1.  Identify Weaknesses

By understanding their company’s shortcomings, sellers can address them before potential buyers uncover them. This can help to avoid surprises and negative negotiations.

2.  Enhance the Sales Process 

A well-prepared seller can streamline the due diligence process for buyers, leading to faster and smoother transactions.

3.  Maximize Valuation 

By highlighting their company’s strengths and addressing potential weaknesses, sellers can position themselves to achieve the best possible valuation.

Types of Due Diligence in Mergers and Acquisitions

Proper due diligence reviews each of the following areas:

  1. Financial  — A financial analysis involves looking at financial statements, accounting practices, fiscal performance, assets, and liabilities. 
  2. Taxes — Tax due diligence helps clarify the target company’s tax obligations and compliance, plus the potential tax liabilities of the buyer. 
  3. Legal — Legal due diligence reviews legal documents (including contracts, licenses, and intellectual property rights) and any legal issues like antitrust investigations or pending civil lawsuits. 
  4. Operational — An operational assessment looks at internal processes, from supply chain management and production facilities to IT systems and quality control measures.
  5. Commercial — Commercial due diligence assesses market share, competitive position, marketing strategies, customer satisfaction, and growth potential.
  6. Technological — These evaluations analyze technology infrastructure and practices, including software and hardware, cybersecurity measures, and data privacy compliance. 
  7. Personnel — From employment policies to compensation programs, human resources due diligence is essential for risk management and integration planning.
  8. Regulatory — This type of due diligence looks at the target company’s industry compliance and the requirements for regulatory approval. 
  9. Environmental — Environmental due diligence focuses on ecological variables like hazardous waste, contamination risks, and sustainability practices.
  10. Reputational — Due diligence should also seek out business intelligence about the reputation and integrity of potential partners.

Need Help With Due Diligence in Mergers and Acquisitions? Contact Us Today

If you are acquiring, selling, or merging with another company, Wilson Ratledge, PLLC, can facilitate the process. We offer professional legal and financial advice on mergers and acquisitions for small businesses and multi-million-dollar companies across various industries. Call 919-787-7711 or contact us online to see what our team can do for you.

Federal Court Issues Nationwide Injunction on Corporate Transparency Act: What Small Businesses Need to Know

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On December 3, 2024, it was announced that Judge Amos L. Mazzant, III of the U.S. District Court for the Eastern District of Texas issued an order purporting to impose a NATIONWIDE preliminary injunction on enforcement of the Corporate Transparency Act, which required most small businesses to report beneficial owner identifying information to the Financial Crimes Enforcement Network. View the order here.

The preliminary injunction has now been appealed.

What does that mean for your business?  Enforcement of the January 1, 2025 deadline is still on hold unless the preliminary injunction is reversed.

We will continue to monitor the developments of this case and provide updates as they unfold.

Find more details surrounding the Corporate Transparency Act here.

WR recognized in the 2025 rankings of the United States Best Law Firms

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Wilson Ratledge is pleased to announce our inclusion in the 2025 rankings of the United States Best Law Firms® as a Metropolitan Tier 2 firm in the practice area of Real Estate, and a Metropolitan Tier 3 firm in Commercial Litigation and Litigation – First Amendment.

The Best Law Firms® ranking is determined through an extensive evaluation process involving peer and client reviews, and industry leader interviews, ensuring that recognized firms demonstrate exemplary legal practice, professionalism, and client satisfaction.  Firms are recognized by practice areas, with rankings presented in tiers on a national and/or metropolitan scale.  There are 127 practice areas, 75 national practice areas, and 188 district metro areas.

The 2025 Best Law Firms rankings can be accessed at www.bestlawfirms.com

Valuation Methods for Small Businesses

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There are numerous reasons you may  want to know the value of your company. In addition to reasons related to a potential sale of the business and allocation of the purchase price to various assets or asset classes, valuation is also important for other purposes such as mergers, business conversions, borrowing, shareholder/member/partner agreements or disputes, estate tax valuation or buyout upon the death of a member, and gifting for estate planning. Many times, appraisals by certified appraisers are necessary or advisable.   

Below are some common valuation methods for small businesses. Valuation professionals often use varied approaches to find a balanced, well-rounded number that more accurately depicts your company’s value. 

1. The Multiple of Earnings Approach

Many valuations are based on a multiple of earnings before taxes, interest, depreciation and amortization (“EBITDA”).  This provides a measure of a company’s operating performance, excluding non-operating expenses and non-cash charges.  

Multipliers vary based on industry, market volatility, business location, risks, and many other factors. Often, the higher the EBITDA, the higher the multiplier will be.

Next, EBITDA will be “normalized,” or adjusted for unusual or non-recurring items. This adjustment provides a more accurate measure of the businesses “normal” operations.

Normalized EBITDA will often be further adjusted to determine the seller’s discretionary earnings (“SDE”), to provide a measure of expected financial value a new owner would gain on an annual basis. These adjustments are sometimes referred to as “add backs” and typically include owner’s compensation, perks and benefits, as well as excess expenses paid to related parties, such as rent if those expenses exceed market value.

Lastly, normalized EBITDA or SDE may be further adjusted, or weighted, so as to give more effect to recent earnings than earnings from two, three or more years ago. This may be referred to as a “weighted average” of earnings over the prior three to five years.

Finally, the valuation professional will determine the appropriate multiplier for your business.  This multiplier will be based on many factors, including the nature of your business, recent transactions in the same and similar industries, and various other market conditions and risk factors.  Often the multiplier is between 3 and 5, however, but could be lower or higher.

2. The Discounted Cash Flow or Capitalization of Earnings Method

The discounted cash flow or capitalization of earnings methods rely heavily on many of the same earnings calculations discussed above; however, rather than applying a multiplier to one year’s earnings, this method projects earnings for a number of years and then discounts that stream of income to its present value.  Instead of a multiplier, the valuation professional must determine a “discount rate” or “capitalization rate” which will reflect a number of different factors such as interest rates, inflation, business risk, etc. 

3. The Adjusted Net Asset Method

Some valuation methods for small businesses focus solely on business assets rather than cash flow, revenue, or earnings. The Adjusted Net Asset Method looks at the monetary value ofyour business’s tangible assets such as real property, furniture, fixtures, and equipment, inventory, accounts receivable, etc., net of loans, financing, payables, and other liabilities. This method is more appropriate for asset heavy businesses as opposed to service businesses and operating companies.

Work With a Business Law Attorney for Personalized Support

Again, there are many reasons you may need or want to value your business.  Typically, a business valuation professional will be advisable or required.At Wilson Ratledge PLLC, our business law attorneys can help you with whatever needs you have that might require valuation, from succession and estate planning, to selling your business.  We can also help you understand the many factors that go into the valuation, and how they affect your needs, plans and goals.a.

Call Wilson Ratledge PLLC today at 919-787-7711 to schedule a consultation with our team.