Sellers Shouldn’t Assume Their Buyer Qualifies

Sellers Shouldn’t Assume Their Buyer Qualifies

Effectively distinguishing serious qualified buyers from "pretend buyers" is crucial for sellers to save time and stress in the evaluating and selection process. A pretend buyer in this context is a potential buyer with no potential of currently qualifying for the bank financing needed. What makes them pretend buyers instead of simply unqualified? Because no-one knows they are not qualified for the bank loan needed for the seller to receive the agreed upon payment structure.

With numerous interested parties, it’s important to recognize that not all possess the financial readiness or eligibility to secure the necessary funding for every acquisition. A common misconception is that larger practices, due to their scale, big AUM number and apparent success, will have no issues qualifying for acquisition loans or would have the required liquidity. However, this assumption can be misleading because there are numerous scenarios where practices you might assume would qualify don’t.

Buyers who have been in expansion mode and who are gearing up with the right infrastructure and people to accommodate future growth can get tight on free cash flow during the ramp-up period to reaching scale. Some established practices with expensive offices in expensive markets, with large staffs, may also find themselves tight on cash flow from a bank loan qualification perspective.

Some sellers assume if they are willing to guaranty an internal advisor or successor’s loan there won’t be any issues with bank approval. This is certainly true for some but it’s not automatically true for everyone, and the willingness to seller finance plays a key role. If you are seeking close to full payment for full valuation when you sell to an internal W2 team/staff member who isn’t bringing additional revenue with them (from underwriting perspective) then the cash flow the bank is looking at is solely reliant on the seller’s cash flow. There is a big difference in cash flow when getting a $2 million acquisition loan where you’re adding revenue vs. one when you’re not.

Sometimes the firms you may think are no brainers in being able to pay you the way you want to get paid have hidden hangups they’re not even aware of yet because they’re just assuming they can get financed in the way needed. After all, if that much smaller advisor they know was able to get a big loan they certainly won’t have any issues can be the thought process. While this may be the case it isn’t always the case by any means. Sometimes the buyer qualifies for a loan but not the right kind of loan for the situation. They may only qualify for an SBA loan which would prevent earn-outs, staying on as a W2 employee, and for partial equity buy-ins any remaining 20% owners have to personally guaranty.

For any of these reasons or more a seller may prefer the buyer who qualifies for a conventional loan if they are set on an earn-out structure. Or they may qualify for an SBA loan but once they dig in they find out that one of the three partners would be required to have a lien on their home and the partners can’t come to a risk equalization resolution.

To protect the seller's (and buyer’s) time and ensure a smoother selling process, it is advisable to focus on financially capable buyers very early in the process. A practical approach is to require potential buyers to present a pre-qualification term sheet from a lender early in the negotiation process. This vetting mechanism not only filters out unqualified buyers but also protects the seller from unnecessarily exposing confidential financial information. Peruse through the buyer profiles on AdvisorPortals and you’ll see a financing pre-qualification badge to easily discern buyers who have taken the steps to know (or verify) they are not pretend buyers.

AdvisorLoans also provides complimentary consultations and loan pre-qualifications. By executing a non-disclosure agreement and having a discussion about your goals and situation, AdvisorLoans will conduct a comprehensive analysis of the buyer's financial health, creditworthiness, and overall acquisition financing potential. This process includes identifying any red flags that could hinder loan approval, and if those obsticles can be overcome and how.

When sellers address financing early in the process then often times issues that come up have time to get resolved before your exiting timeline comes. For some sellers this process filters out a buyer they don’t know and for others it positions the buyer they do know or have selected as their successor with guidance to structure the financing needed.