There are several options when it comes to financing a business. Seller Financing is when the owner is willing to personally finance a portion of the purchase price. Oftentimes, this increases the likelihood of closing a purchase transaction. While Seller Financing is tempting because of the heightened chance of a faster sale, it is a serious consideration that needs to be deeply evaluated before attempting. What should you know before utilizing seller financing in a business purchase?
6 tips to consider when using Seller Financing:
1. DO assess the risks. Sellers will be tied to the business long after the sale is complete.
When a seller finances a business, the seller continues to be tied to the business for a pre-determined amount of time after the sale is complete. If the business succeeds, the new owner pays back the principal with interest and everyone is happy. If the new owner fails, however, the seller could suffer the loss of interest income and incur additional costs to collect the debt.
The bottom line is that a seller-financed sale needs to be evaluated as a business investment. Like any other investment, there is a certain amount of risk inherent in the decision. If the seller is comfortable enough to invest in the new owner, then it could be beneficial for the seller to finance the sale. It will close the deal more quickly, the seller typically receives a higher asking price, and the seller earns income from collected interest.
2. DO leverage the benefits of an interest-earning investment.
Seller willingness to carry the note in a seller-financed transaction is an interest-earning investment. If the buyer is good investment risk, the seller stands to reap substantial benefits from self-financing. Too many owners view sellers financing a business as a desperate measure to unload the business when they should be viewing it as a resource for enhancing the benefits of the sale.
Immediately, seller willingness to hold paper increases the final selling price of the business. Partially-financed sales typically result in a price that is more than 15% higher than their cash sale counterparts. That means sellers can leverage their willingness to finance as a bargaining tool during negotiations.
The other big benefit of offering seller financing is the potential to multiply the principal value of your business through future interest payments. As you might expect, a financed sale garners a much higher rate of return than many other investment vehicles with a 5-7 year note at 8-10% interest as the norm. Sellers should remain firm on charging the amount of interest that is appropriate for the market and the level of risk assumed.
3. DO advertise seller financing when you list a business for sale.
Advertising seller financing of a business for sale can be a big plus that attracts more buyers. If the seller is comfortable with financing part of the sale, he or she should include that information as a selling point in the marketing efforts. Offering seller financing attracts a larger pool of serious buyers, including those who may not otherwise have the ability to secure financing at the asking price.
4. DON’T waive the down payment. A healthy down payment can minimize risk.
Seller financing can be a risky venture. A healthy down payment, however, can minimize exposure by distributing an equal or greater amount of the risk to the buyer. Unlike home mortgage lenders, who sometimes require a down payment of 15% or less, business purchase loans usually require a much higher upfront investment.
Generally speaking, it’s in a buyer’s best interest to finance no more than 20 to 50% of the sale price. If the buyer decides to finance more than that, they need to have a legitimate reason for doing so. For example, if selling the business to a family member, the seller may have a vested interest in financing an amount beyond the normal range. Yet, as financing commitments increase, so does risk.
5. DON’T do it yourself. Get legal and professional advice.
By definition, seller-financed business purchase transactions contain shades of do-it-yourself. Instead of relying on professional lenders for financing, the seller assumes the responsibility for a percentage of the buyer’s investment. Get someone with professional experience to assist you.
6. DON’T be pressured. Trust your instincts.
There’s a good chance that potential buyers will try to push for a seller-financed business deal. This is particularly true for buyers that are unable to secure financing from traditional lending sources due to an inadequate down payment or other borrowing obstacles.
No matter how anxious someone is to sell the business, caving into buyer pressure for the sole purpose of closing the deal is a big mistake. When a buyer pushes too hard for seller financing, take a step back and conduct a simple reality check. If a seller isn’t completely comfortable with financing the buyer’s purchase, they should walk away and wait for a better buyer candidate to emerge.
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Edwin Mysogland, CVA, CEPA, CMEA
Managing Partner, Indiana Business Advisors
Indiana Business Advisors is the top business brokerage firm in the state of Indiana and one of the largest in the Midwest. Whether you are looking to a buy a business or sell a business, Indiana Business Advisors has the expertise and experience to get the deal completed. With over 40 years of history and 2200 businesses sold all over the United States, our team will work diligently to achieve your professional and personal goals.