Acquisition Financing: Benefits for the Buyer and Seller

Acquisition Financing

The death care industry has experienced an increase in consolidation and acquisitions in the past decade. In the 1970’s, nearly 100% of funeral homes were privately owned. Today, that number has dropped to 85%.1 This trend is likely to continue as a majority of current funeral home owners approach the age of retirement.

This demographic shift in ownership creates an opportunity for the next generation to become owners. It also creates a market for current owners looking to expand their businesses through an acquisition.

As an owner approaching retirement, it is important to have an exit strategy to ensure the business you’ve built continues its legacy. Proper succession planning should begin a few years in advance to ensure you have the liquidity to live out retirement as imagined.

As the buyer seeking to acquire the funeral home, consider the people you need on your team including a lender, a financial advisor and a lawyer to make the transition successful.

Historically, seller financing was the primary method to complete the transaction, but today, buyers have financing options through financial institutions. To successfully complete the transaction and diminish transition risks, both the seller and buyer need to understand the process and financing options.

Determine the Purchase Price

Agreeing on the purchase price is a fundamental step that should occur early in the process. The purchase price should be based on a combination of asset values, annual revenues, multiples of earnings and other intangible assets. The building, land, equipment and furniture will constitute the tangible assets.

If the real estate is included, it will be necessary to have an appraisal completed. A business valuation by professionals who understand the death care industry can assist both parties reach a fair price.

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Financing Options

For many funeral home owners, deciding to sell their businesses is a major life event. Historically, the lack of financing made transactions difficult to complete. Many lenders do not understand the intricacies of the funeral space; therefore, the structure of the deal may not benefit both the buyer and seller.

For example, a conventional lender will lend on the real estate value often excluding goodwill. If the funeral home is worth $2,000,000 total with the real estate value as $1,000,000, a conventional lender will lend around 80% of the real estate value or $800,000. In most cases, the buyer cannot make up the difference, so the seller must hold $1,200,000.

However, when working with a cash flow lender, the goodwill or intangible assets of the business are taken into consideration, and the transaction is attainable. Lenders who understand the unique aspects of a funeral home business will be able to structure the loan to best benefit both parties. For example, the loan terms may improve if the crematory is classified as real estate rather than equipment. Small changes in the structure can greatly affect the outcome.

In some cases, the transaction will require a seller carry note. While some owners shy away from this option, it can benefit both parties and make the acquisition possible.

Depending on the price of the goodwill, the buyer may be asked to provide an equity injection. However, if both parties agree to a seller carry note to cover the equity requirement, the buyer will benefit by only having to put a minimal amount down at closing.

Typically, the buyer and seller will agree to terms of the seller note. This structure allows the seller to obtain the asking price of the funeral home while earning interest on the seller note. While no investments are risk-free, typically a seller note will have a greater return than traditional investments like a certificate of deposit. Furthermore, it provides the seller a source of income as the buyer pays monthly. It is best to consult with an attorney and tax advisor when structuring the seller carry note.

When selecting a lender, make sure they have experience lending to funeral home owners and can explain the financial benefits for both the buyer and seller.

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Securing Financing

Ultimately, a lender will base an approval on the funeral home’s financial strength and the buyer’s personal credit.

The seller will need to provide the lender with the funeral home’s prior three years’ tax returns, a profit and loss statement and balance sheet. The seller should prepare the required financial information in advance to achieve the highest possible sale price and lessen the chance of delays in the lending process.

The lender will use these documents to perform a cash flow analysis on the business to determine the borrower’s ability to repay the loan, cover the business’s expenses and support his or her lifestyle. Essentially, cash flow is the difference between revenues (or sales) and expenses that a business incurs in any given period. If there is more cash coming in from revenues than going out from expenses, the cash flow is positive. Conversely, if expenses are higher than revenues, the cash flow is negative.

A lender will look at the buyer’s personal credit in addition to the business’s financials. How someone manages his or her personal credit is typically a strong indicator of how he or she will manage the business’s credit. When preparing for financing, the buyer should take steps to protect personal credit and avoid making any purchases that will affect his or her credit score.

Furthermore, the lender will want to ensure the new owner understands the competition and market trends. The buyer should be prepared to talk about the business plan and any plans for improvements.

As more funeral homes are transitioning ownership, it is essential that both buyers and sellers are prepared to take advantage of the opportunities available. Working with a lender who understands the current landscape and how to best structure the financing will guarantee the transaction is a success.

Resources

  1. NFDA Trends and Statistics, http://nfda.org/about-funeral-service-/trends-and-statistics.html