Whether you are looking to buy or sell a business, 'seller financing' is an important concept that affects many small-business deals and should be fully understood by both parties.
What is Seller Financing?
At a high level, seller financing (also known as a ‘seller note’) is a loan the current owner of a business (seller) provides to the prospective new owner (buyer) to cover a portion of the purchase price.
Benefits of Seller Financing
At first glance, many sellers are hesitant to provide seller financing on a business based on the perceived risk that the buyer won’t pay them back. In reality, however, a seller financing business for sale can benefit all parties. It can give buyers access to capital to buy a given business while helping sellers attract more buyers, and earn more money on the sale. Better understanding what is seller financing can help sellers be more comfortable in providing it when selling the business. Some examples of these benefits for the seller include:
- Ability to earn interest- Seller financing is a loan. Therefore, there is an interest rate. As a seller, you will earn interest on the portion you commit to financing.
- Attracts more buyers- Offering seller financing provides a simple way for buyers to combine financing methods and move closer towards closing. It also shows that you’re confident in the future success of the business you are selling since the buyer's ability to repay you may depend on it.
- Mental relief- Selling a business is a two-way street. Offering seller financing will give you more control over the selling process, and you will better understand the buyer so that you know that your business will be in good hands.
What Does the Process Look Like?
As mentioned above, an ownership transition of a business is a two-way street. Just as a prospective buyer will conduct their due diligence to inspect the overall competency and opportunity of a business, a seller should always thoroughly assess the buyer- especially if the offer includes a seller note.
In such cases, the seller acts a lot like a bank does when providing financing. They can (and should) check out the prospective buyer’s professional background, the reason for purchasing the business, financial qualifications - including personal financial statements, a credit check, as well as any other relevant information needed to weigh this financial decision. Sellers can also request collateral to further secure the loan. It is in the seller’s best interest to perform all these checks because after all, the goal is to get your money back (plus interest).
What Are Some Typical Seller Financing Terms?
Every deal ends up taking a unique structure. Nevertheless, there are some commonly accepted terms that can act as a good rule of thumb when structuring seller financing. Typical seller notes look like this:
- Loan Amounts: 15-40% of the purchase price
- Term Length: 5-7 years
- Monthly Interest Rates: Must be competitive with bank rates and other lenders for the buyer to consider
Protections For Both Parties
At the end of the day, it comes down to trust. However, there are certain measures that can be taken to protect both sides. A seller’s biggest fear when providing seller financing is, of course, the buyer defaulting on the loan. To avoid this from occurring, sellers generally want terms that give them the right to take back control of the business within a set time period of the buyer's missing payments.
It is also important for buyers to understand what is seller financing. Buyers generally view seller notes as both a means of financing but also as a commitment from the seller. A seller willing to hold out on an immediate payday can, in some ways, show that the seller isn’t going to simply sell and skip town. They are willing to stay financially tied to the business which further displays their belief in the quality of the business sold.
One Key Tip
As a seller, you should be upfront about your willingness to participate in a seller financing event and have a rough idea of the terms you’d like.
These actions will not only attract more buyers from the start but will really help lay out the blueprint for the entire selling process. In an ideal world, all sellers will openly disclose whether or not they are willing to consider providing seller financing.
We know, however, this isn’t always the case. If the intention of offering seller financing is not clear, buyers should try to find out the verdict as soon as possible. The earlier you bring it up, the quicker you’ll know, and the clearer your pathway to financing becomes. Plus, you want to avoid the awkward conversation of bringing up late in the sale that you require them to provide seller financing. In many cases, this will cause sellers to get cold feet and pull out of the deal.
Outside of cashing out, most times sellers want peace of mind that they are selling to a good person. Someone who is going to hold their company in good hands, treat the people in and around the business well, and someone who has a vision for the future of the company. Nobody can run a business forever, therefore succession is natural, and knowing what is seller financing and how it can help this transition is a very common path.