Whether you are looking to buy or sell a business, ‘seller financing’ is an important concept that affects many deals and should be fully understood by both parties. At a high level, seller financing (also know 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, or the full amount of the purchase price.
At first glance, many sellers are hesitant to provide seller financing based on the perceived risk that the buyer won’t pay them back. In reality, however, seller financing can benefit both the buyer and the seller. It can give buyers access to capital to buy a given business while helping sellers attract more buyers and ultimately get more money on the sale.
Remember, an ownership transition of a business is a two-way street. Just as a prospective buyer will conduct his/her 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, 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 the money back, plus interest (we’ll talk about that a little later).
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
Payment Schedule: Monthly
Interest Rates: Must be competitive with bank rates and other lenders for the buyer to consider.
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 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 missing payment. Some buyers 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.
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, but will really help lay out the blueprint for the entire selling process.
In an ideal world, all sellers will openly disclose whether they are willing to consider providing seller financing. We know, however, this isn’t always the case. In the possibility that 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 provide seller financing. In some instances, sellers have actually gotten cold feet and pulled out deals where this occurs.
Wrapping it up
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 helping this transition via seller financing is a path taken by many.