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There are a variety of ways for a buyer to finance the acquisition of a business they seek to purchase. Many who cannot afford or choose not to pay the full purchase price and may have trouble obtaining a loan from a bank will look to the seller to provide financing to facilitate the sale.
With seller financing, the owner of the company virtually acts as the business buyer’s bank, creating a loan agreement to allow the purchaser to pay some portion of the purchase price to the seller at closing. It then provides for how the buyer will pay off the remainder over a specified period of time and at what interest rate.
Seller financing, also known as owner financing, is extremely common. It’s estimated that more than half of all business sales involve at least some seller financing. A seller-financed business acquisition can be a great option that offers advantages both financially and through speed of sale. If you are a business owner who might consider personally financing the sale of a business, here are six tips to help you structure a seller financing deal.
When sellers finance the business for sale, it ties them to the business for the near future, with principal and interest payments arriving on a previously agreed-upon schedule. As long as the business is successful, those payments continue. However, if the business hits the skids, the seller could see payments slow or stop altogether. The resulting loss could also include the additional expense of trying to collect the outstanding debt. Therefore, if you are not confident the buyer can run the business successfully, you may be better served not to offer financing.
To help you make that decision, there are a number of things you can do to reduce the risk of a buyer defaulting. The process is not unlike hiring an employee for your business. You should start by conducting due diligence regarding the financial qualifications of your buyer, which would include their general background and character, credit record, personal assets, management experience, and any ownership of other similar businesses.
Remember, you are placing a bet on that buyer’s ability to operate your business well enough to maintain or increase its value and generate the necessary cash flow to make payments on the debt.
With an owner-financing business buyout, not only do you likely increase the final selling price of your business; you make additional revenue from the continuing interest payments. For most owners financing a business for sale, this more than makes up for not receiving the large upfront payment.
Additionally, because a partially-financed sale can be leveraged as a bargaining tool during negotiations, the sale price of the business will often be higher than the cash sale price.
But the biggest benefit is your potential financial gain through all the future interest payments. A financed sale will provide you with a significantly higher rate of return than many other investment opportunities. For example, if you consider a rate of 8-12 percent for a period of 5-7 years, it is easy to see how carrying some risk can be very lucrative.
Sometimes, sellers are hesitant to advertise a business for sale with seller financing because they feel that financing option should only be used as a last resort. However, in fact, the opposite is true. With a seller-financed business for sale, you will attract a larger pool of potential buyers, giving you more opportunity to get full value for your business. So, it only makes sense to not just include your willingness to finance but to feature that possibility in any listing or marketing of the business sale.
Unlike a home mortgage, where lenders typically accept down payments of 10% or even lower, an owner-financed business for sale will require a much higher upfront investment. A respectable down payment will help minimize your financial exposure by placing more of the risk on the buyer.
A typical seller financing business agreement may see an owner extend a loan for a portion of the sale price, usually less than half the total price, with the buyer paying the rest upfront in cash. Just remember, as your financing commitment grows, so does your risk, and that would justify you requesting a higher interest rate on any financing deals over 50 percent of the selling price.
Even if you’re a seasoned entrepreneur and business maven, selling your business—even if it is a small one—is not something you should try to do on your own. There are contracts to be created and a litany of regulations to comply with, as well as tax implications to understand and provide for.
Given the variety of ways that exist for how to structure a seller financing deal, it is highly recommended to find professional assistance. You may be best served seeking appropriate guidance from financial professionals, such as an accountant, a business appraiser, or even a broker. But, at the very least, you should hire an experienced attorney to assist you with the legal components and any contracts you sign.
In most cases, prospective buyers are simply looking for an opportunity to buy a business and to make a reasonable return on their investment. As a result, they are very often going to be reasonable about their needs in securing the business. However, it is not unusual for a potential buyer who is unable to secure adequate financing on their own to lean heavily on the seller to provide the financing. But the buyer’s inability to deliver an adequate down payment is not your responsibility, nor is it to assist them with other barriers to borrowing. Buyers should understand that sellers who offer their own financing like a bank must also act a lot like a bank.
Don’t let your desire to see the deal completed cloud your vision. As a buyer becomes more insistent that you carry additional weight in the deal, it is important to keep your perspective and know when the time is right to walk away. Trust your instincts and wait for a better deal—or a better buyer.
In challenging economic times such as these, creativity in deal-making has become the norm in order to secure the deal you seek. The simple truth is that unless you are willing to finance at least some of the cost of acquiring your business, it could potentially be a more lengthy and difficult process to sell your company. From a buyer’s perspective, seller financing is seen as an indicator that you have faith in the future of your business.
Seller financing does come with a certain amount of risk. But if you can get comfortable enough to invest in the prospective owner, financing the sale yourself can be a powerful boost that enables you to close the deal more quickly, secure a higher asking price, and pocket additional income from future interest payments.