Did you know that the large majority of business sales include some type of seller financing? In fact, seller financing is involved in up to 90% of small business sales and more than half of mid-sized sales.
Many sellers would love an all-cash deal.There is no risk involved - sell your business, collect your money and go your merry way.
But sadly, most buyers don't have that kind of cash lying around. And, tightened bank lending criteria has greatly curtailed the amount of funds available to would-be buyers.
Business sales are often a combination of the buyers' capital, bank financing and seller financing.
So, if you own a business and are thinking about selling it someday, then this is a topic you should get smart on.
What is Seller Financing?
Seller financing is similar to a bank loan, but with the seller acting as the bank. A promissory note is drawn up between the two parties outlining the terms, conditions, interest rate and schedule of payments.
Seller financing generally ranges from 20 - 50% of the purchase price with a term of 5 - 7 years. The note is amortized over 30 years, with a balloon payment due at the end of the term. The expectation is that the buyer will be able to refinance the debt with a traditional loan at that time.
Under the right circumstances both the buyer and the seller can benefit from seller financing. But beware, there are some very real risks involved.
The Good News
Seller financing can help get a deal done that might otherwise languish due to financing barriers for the buyer.
Also, partially financed business sales typically result in a price that is more than 15% higher than their cash counterparts.Your willingness to finance is a strong bargaining tool during negotiations.
And, seller financing can be a good investment with interest rates generally higher than traditional notes. So, the seller can make a nice profit from the deal.
Lastly there can be tax benefits as the taxable income from the sale is spread over time.
Gotchas
The most obvious risk for the seller is that the new owner fails. The seller could suffer loss of principal and interest income and incur costs to collect the debt. In the worst case, the seller could repossess the business. If you aren't confident the buyer can succeed, then think twice before financing the deal.
Another downside to seller financing is that the seller continues to be tied to the business for years after it is sold. This may not sit well for the seller who wants a clean break or needs the capital for other purposes.
5 Do's and a Don't
DO make sure the buyer contributes a significant down payment with his/her own money. They need to have skin in the game and an incentive not to default.
DO get collateral and/or a personal guarantee. A bank would insist on it, and so should you.
DO perform the appropriate due diligence on the buyer. You want to lend to someone with strong credit history.
DO get financial and legal advice. The promissory note is a legal document that could have significant financial ramifications if not executed properly.
DO consider requiring the buyer to take out a life insurance policy with you as a beneficiary in the event s/he should pass unexpectantly.
DON'T provide financing to a buyer you don't think will succeed.
