Seller financing is when the seller of the business helps the buyer finance the purchase of the business acting as a bank or lending organization on behalf of the buyer. Many sellers will offer seller financing, which essentially means you, the seller, will be operating as the bank offering a finance mechanism for the buyer to purchase your business.
- Only offer seller financing if you’re willing to get paid over time and never DIY the seller financing process.
- Work with a lawyer or broker to help you make sure you're getting the money you deserve.
How Does Seller Financing Work
Seller financing works similarly to a bank’s lending process, only with the seller operating as the lending entity. Typically, the seller will offer a loan that’s a portion of the sale price and the buyer will have to pay for the rest at the time of sale. Here’s a quick step-by-step process for entering into an owner financing agreement:
- Do your due diligence. Before signing any sort of business agreement, make sure you understand who your buyer is. You’ll want to look at your buyer’s credit score, you’ll want to ask them for a full-fledged future business plan, and you’ll want to see as many financial documents as you can. This is the only way to ensure you won’t end up with no business and no hope of repayment.
- Work with a business broker to draw up terms. Unless you’re well-versed in the world of business, you’ll need to work with a lawyer or business broker to help you draft a legally binding agreement. They can help you understand how much you should charge in interest and what you should look for when it comes to a down payment. They should also help you when it comes to deciding how to transfer business ownership.
- Make sure the buyer offers up collateral. In the event that your buyer can’t make monthly payments, having something as collateral allows you to seize an asset (or potentially the whole business) so you can make up for the cost of the missed payments.
Seller Financing Benefits for Buyers
Seller financing can be a very attractive offer for many buyers and comes with many positives for potential buyers and sellers alike. For buyers, here are a couple of pros of going with seller financing:
- More lenient borrowing. While sellers won’t accept just any buyer under seller financing, they definitely aren’t as harsh as some banks. Maybe you’ve heard of folks who always reminisce about “old-time” banking where an actual person, rather than an institution, decided your loan terms. This is how seller financing works. A buyer and a seller agree to terms that are often mutually beneficial.
- Better terms. Sellers often want to close a deal more than the bank, since it’s such a personal sale. That means sellers can offer better terms like lower interest rates and potentially longer borrowing times in an effort to secure the best buyer.
- Faster buying process. There’s a lot of red tape when it comes to getting a loan via a bank, so the process can take weeks or months. Sellers can expedite the process since they’re the ones making all of the decisions and there are no extra layers of approval needed.
- Still a similar process to borrowing from an established bank. The actual borrowing process will be similar to a bank, which isn’t all bad. For buyers, that means a regular schedule of payments to be paid off fully in a timely manner.
Seller Financing Benefits for Sellers
Seller financing can be the right move for many business owners looking to sell. You’ll need to be willing to hold out for the full amount of your asking price, but it could lead to a better outcome down the road. Here are a few seller financing pros:
- Sellers often get a higher price through seller financing. Owner financing a business for sale means the seller is the one earning interest on the loan, not a big bank. That’s money directly in your pocket, often over a few-year period. Additionally, because sellers don’t have to deal with closing costs, that’s more of the selling price you get to keep.
- You may have a larger number of buyers to choose from. Seller financing is an attractive financing option for buyers, so if you list this option when you sell, more buyers could flock your way. This means you’ll have a variety of offers to choose from and you can take the one that works best for your timeframe.
- There may be tax benefits. When you sell a business without seller financing, you’ll be hit with capital gains tax. But spreading out the income lets you spread out this tax over multiple years.
Disadvantages of Seller Financing
There’s a reason banks do exist. Offering seller financing may be a good move financially, but it’s not exactly easy. Plus, well-qualified buyers may still be losing out on a better financing option. Before deciding that seller financing is the right move for you, consider the following:
- Seller financing can be risky for the seller. While you get a chance to make more decisions with seller financing, you do now have to operate as a bank which means you’re taking on some significant risk by doing so. And the difference is, that your finances might not be able to handle non-payment like a bank can.
- There’s no clean break from your business. If you’ve decided to sell and want to relinquish the business completely and as fast as possible, seller financing won’t be the right move for you. You’ll be tied to the business for as long as the loan term you agree to.
- Sellers will need to have the finances to offer this financing. While many seller financing deals will use the business itself as collateral, you’ll still need to have the financials to fund a seller financing loan.
Seller Financing a Business Acquisition: Case Study
While business deals look different from deal to deal, let’s consider one specific seller financing example to show you have a simple seller financing arrangement.
Say Clark owns a bookstore and is looking to sell it for $500,000. Jim wants to buy it, but doesn’t have a squeaky-clean credit history (hey, who does?) and can’t pay such a high asking price upfront (again, who can?). So, when he learns that Clark is offering seller financing, he’s excited, to say the least.
It’s up to Clark (and his lawyer and/or broker) to come up with the terms of the agreement. Here’s what they come up with:
- Down payment: 40%, so $200,000. That leaves $300,000 the seller will finance.
- Term: 10 years.
- Interest rate: 4%.
- Monthly payment: $3,037.
- Collateral: The business itself. So, in the event of non-payment, the original seller will get the business back.
Compared to double-digit interest rates that banks charge, you can see how Jim is getting a pretty good deal from Clark. Additionally, Clark is making out with over $60,000 in interest payments over 10 years, which makes it worth it for him to offer seller financing.
Tips to Keep in Mind When Seller Financing a Business for Sale
Selling a business isn’t an easy task. When you offer seller financing, the process can get a little more complex on your end. In order to make sure your making the smartest moves for your sale, keep these tips in mind:
- Do just as much due diligence as a bank. Before offering any potential buyers a deal, you’ll need to do a lot of background research beforehand. Like a bank, you’ll want to check your buyer’s credit score, their business plan, and their previous financials. You’ll want to ensure that the buyer will be able to pay you back over time.
- Advertise that you’re offering seller financing. Seller financing is a selling point (pun intended) for many buyers, so you’ll want to let them know that you’re offering it.
- Get a large down payment from the buyer. The more you get upfront, the less risk you’re taking on. Even if you offer seller financing, consider the offers that are willing to pay large down payments.
- Ask for some form of collateral. In order to protect yourself, you always want to ask for a form of collateral. This will help make sure you get the money you’re owed, even if the buyer stops making monthly payments.
- Don’t DIY the seller financing process. Although you’ll be the one in charge of the whole deal, you definitely still want some help. Work with a legal team and/or a broker that can advise you on the best course of action.
A seller financing business for sale will likely draw in many potential buyers, as it offers more lenient buying terms for them. At the same time, you’ll cut out the middle man (big banks) and be the one that earns interest on your sale. As the seller, you’ll need to decide if the seller financing commitment is worth it to you, or if you’d rather sell your business in full at the beginning of the sale process.