A Guide to Seller Financing

What is Seller Financing?

Financing is a difficult topic to address and one that comes up frequently in the brokerage business. The sheer number of options and varying business conditions makes each financing situation unique. At Transworld, we specialize in working with buyers to find the optimal financing option for their specific situation. Some of these options are well-known, like paying cash or pursuing bank financing or even the use of private investors. But there are other financing options, like seller financing, which can help your business become more attractive to buyers and get your business sold.

Seller Financing involves a short-term, promissory note (essentially a contract) between the buyer and the seller. To utilize this option a down payment is agreed upon by the buyer and seller and included in the terms of the promissory note. Typical terms could include a down payment of 40-50%, and the remaining balance to be paid over a certain duration, usually 3, 5 or 7 years. An interest rate for the remaining balance of 4-7% will also be included.

The Pros and Cons of Seller Financing

The overall benefit to Seller Financing is a more streamlined transactional process. The pros and cons of seller financing differ from the standpoint of the buyer to the seller. For the buyer, Seller Financing allows for some residual "skin in the game" meaning that the seller still has a vested interest, concern, and confidence in the future growth and stability of the business.

The benefits for the seller include maintaining a stronger position when asking for a better sale price, along with an overall faster sale transaction process because of the financing built into the transaction. On the flip-side, buyers are aware that they are required to sign personal guarantees for the loan, as the sellers are acting as the loaning bank. The risk of default increases for sellers when unqualified buyers are involved. However, at Transworld, we take precautionary measures to ensure and confirm that our buyers are highly qualified to participate in Seller Financing even before they begin to look at your business for sale.

Finally, using Seller Financing allows the seller to reap a higher return on their equity while deferring income tax. In other words, the seller reaps the benefits of regular additional income stemming from accrued interest on the amount the buyer owes. And since the seller is not receiving a large lump sum of money following the sale of their business, they can enjoy tax deferment and will not need to worry about being pushed into a higher tax bracket.

An Overview of Seller Financing within Business Transactions

According to BizBuySell.com only 20% of listed businesses actually sell. These numbers alone will make any business owner leery of the selling process and then add in what seems like the daunting task of actually preparing your business to sell, it can difficult to decide if selling your company is a worthwile endeavor.

The majority of business sales today include some percentage of owner financing (80%+), inclduing SBA financed transactions. Most banks will require at least 10% owner financing as part of the loan process. And businesses that include seller financing within their marketing description generate significantly more buyer inquiries and a 15% higher sale price, according to BizBuySell.com. Seller Financing can put both parties at a true advantage, by facilitating an efficient and affordable transaction.

Delving Deeper into the Why of Seller Financing

Seller financing is essentially a loan provided to the buyer of the business by the seller of the business. Buyers like to negotiate seller financing for a number of reasons, such as:

1. The buyer cannot afford the business at the full asking price.
2. This particular business transaction will not qualify for bank financing.
3. There is uncertainty over whether the business can be successful without the current owner.
4. The buyer wants to use bank financing.

In addition to the buyer's reasons, an owner's willingness to finance a portion of the sale gives the business an edge over the competition, because it removes some of the buyer's uncertainty over purchasing.

How is the Seller Protected When Using Seller Financing

Using a business brokerage firm like Transworld and an attorney is a key aspect of properly protecting a seller within a seller financed transaction. Developing documents that protect both the buyer and the seller during the length of the transaction is integral to its success and this takes professionals well versed in using this financing method. As mentioned earlier, a promissory note will be drawn up that illustrates the details of the agreement. This will include the recourse that can be taken by the seller if the buyer goes into default.

As an example, with the sale of a small business, the most likely recourse scenario would be that the seller has the right to seize the business back. Additional recourse options can be using the assets of the business as collateral or getting a personal guarantee from the buyer. A professional broker will be able to negotiate any of or a combination of these terms into the promissory note to protect the seller from negative events, with the help of the transactional attorney.

Another form of protection for the seller is to conduct due diligence on the buyer, while the buyer is doing their due diligence on the business. Transworld recommends that the seller request credit records and references, at the very least. Understanding the buyer's background, business and financial qualifications, as well as their motivations for purchasing the business, can be very enlightening for the seller and the future of the transaction.

The Promissory Note

The terms of the promissory note are constructed in order to give the buyer adequate time to repay the note. The payment amount must be calculated so that the buyer can afford it while also running the business at an optimal level. This is to make certain that the loan terms are not so constricting that they run the buyer out of business and at the same time not so loose that the buyer can coast on the seller's loan.

For this reason, the term length of the Seller Financing varies depending on such factors as the amount of the loan, current and projected revenue of the business, capital investment of the buyer and their financial qualifications. The interest rate attached to the loan is generally in line with current banking rates, so there is little variation seen here.

Seller Financing Comes Full Circle

Seller Financing is a little talked about financing method that allows both the seller and buyer to reach the optimum transactional outcome. It provides the seller a better chance at snagging a good buyer by providing price appeal and a performance bond and it affords the buyer greater financial capability on the path to purchasing their favored business.

Transworld Business Advisors' team of experienced brokers are experts at navigating the business sale process. For more information on seller financing visit www.tworlddenver.com or schedule a consultation with a broker.

 

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Al Fialkovich is the Managing Director at Transworld, a company he co-founded with his business partner and wife, Jessica. He's a Certified Business Intermediary (CBI) through the International Business Brokers Association and a business savvy advisor to mature businesses as well as a trusted counselor to the business community assisting visionary entrepreneurs to sell, acquire, and establish new businesses. Inspired by the business communities in Florida, New Jersey, Pennsylvania, Massachusetts, and Colorado, Al works hard to help business owners navigate the challenges involved in selling their companies. His experience falls into a wide variety of industries including B2B & B2C services, construction, manufacturing, distribution, and professional services. This knowledge combined with his role as a business owner of over 10 companies allows him to offer clients a unique combination of service and perspective.