Business owners want to know how to go about acquiring assets that a growing business needs but can't necessarily purchase right away. One specific question area within this topic deals with whether there are any ways that the seller can assist in the purchase of capital equipment. And the answer is definitely yes. The deal would work something like this example.
A metal fabricating company needs to upgrade its assembly line equipment. New machines and accompanying apparatus will run about $630,000 from a national sales rep. This will require a minimum cash down payment of $200,000, with the $430,000 balance borrowed from a bank and quarterly payments for 10 years. Another option is to go through the OEM's commercial leasing office and put $100,000 into a front-end lease capital reduction and make 60 monthly payments. At the end of the five years, there's a huge residual to pay off to own the machinery, or the assets revert back to the OEM-lessor.
But a third alternative works like this. The company locates a larger firm within its industry that is interested in selling some of its semi-automated metal fabricating machines that are only 6 years old and have been very well-maintained to the OEM's specs and service agreement. They are almost fully depreciated by the owners. The small firm agrees to pay for the transport costs to pick up the machinery and move it to the new site. They also agree to pay for all the legal costs of the paperwork to cover the exchange transaction. From the large company's perspective, the equipment is out of its factory (at no cost), and the legal documents for transfer are ready to go as well (also at no cost).
The small firm agrees to make quarterly or monthly payments to the seller based initially on the variable output actually manufactured on the equipment, then later at a fixed monthly payment regardless of output. This will cover 18 months (the initial variable output period while the machines get ramped-up to new output requirements), followed by 42 months of fixed payments. During the 60-month term, the small firm also agrees to make two balloon payments toward the principal (the purchase price). One will be after three years and the second after four years. The seller agrees to carry the deal at a low interest rate (prime plus 200 basis points), has the machines as collateral on the repayment, and also has a commercial asset-liquidator at the ready to come in and dispose of the assets in the event the buyer cannot maintain the payment schedule. In addition, the seller might request that the buyer pledge some other tangible assets as collateral on the repayment of the machinery balance over time.
And this entire deal happens at a much reduced price compared to the new equipment from the OEM (perhaps around 62 cents on the dollar, or just $390,000 in this particular case). While the buyer covers all the removal, transport and legal costs, the seller was willing to help the buyers get set up with the existing maintenance firm that handles major service of the machines twice per year and allowed the buyer to tap into the large firm's regular maintenance manual and the person with the expertise at the large company who has handled this task over the past six years. All in all, the large firm got its old equipment removed at no cost, converted the near-fully depreciated asset into 60 months of cash in-flows, and the buyer got the equipment it needed at a reduced cost, with lower payments, less upfront out-of-pocket fees (just transport and legal) and was able to tap into the existing service-maintenance process for continued operations.
Seller-carried paper is a great way to create your own business financing option that has good benefits compared to new-asset terms from the OEM and your local bank.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.