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Business strategy: should you finance your way out of your own business?

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Many Australian businesses are on the selling block due to the glut in the pending retirements of baby boomer business owners. Quite simply, they need to sell to retire.

The subject has received its fair share of column inches – a trend that’s likely to continue in the current buyers’ market.

According to the September Quarter 2011 BizExchange Index, the number of businesses for sale rose by over 350%. Meanwhile, their prices halved.

With banks battening down the hatches, many Australians have been unable to secure funding. As a result, they’re either slashing the value of their business for a quick sale (which drastically reduces retirement coffers) or deferring their retirement until they can find a price that’s right.

The BizExchange Index said ambitions of potential Gen X and Gen Y business owners were also being hobbled by a lack of funding.

“With Gen X and Gen Y unable to access their superannuation savings to purchase their own business, and already heavily in debt due to high housing prices, funding of the business purchase is going to be an ongoing issue.”

Australian advisory and investment house, Pennam Partners, say the current bank lending rule of thumb – 50% gearing with the incoming business owner expected to fund the remaining purchase consideration – is a massive impediment to small and medium business.

While there are a handful of buying alternatives, such as deferred consideration or part cash/part equity, most require the vendor to maintain some sort of ‘skin in the game’.

According to Pennam Partners, most vendors were unsold on the idea. Why should they finance the buyers for two to five years and get paid out of their own profits?

So is there an alternative that all parties can get on board with?

Pennam Partners recommends would-be buyers explore revenue royalty financing (RRF) as a way to get their mitts on the business they covet.

RRF is a funding mechanism that assists businesses to raise growth capital. It’s been used offshore – primarily in the US – for decades. Here’s how it works, broadly speaking:

  1. The RRF investors fund part of the acquisition proceeds
  2. In return they’re entitled to ‘royalty’ payments computed on the (future) revenue of the business
  3. Funding is akin to debt financing, with different permutations depending on circumstances.
  4. The investor has the right to the revenue prior to the expenses of the business being funded.

With RRF there’s little or no equity dilution. Therefore, the incoming business owner maintains full control of the business. What’s more, the newbie owner needn’t hurry to plan an exit strategy as there’s no third-party equity investor.

Speaking of equity, as no stake is being provided, a valuation of the business is of little to no importance, and typically a director’s guarantee isn’t required.

Is a trade sale part of your exit strategy? If so, what are your plans?

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