Seller Financing the Sale of a Business: Do's and Don'ts
Seller financing is common in the business for sale marketplace, with business owners offering to accept payments over three to seven years for some portion of the overall business sale price. Oftentimes, this increases the likelihood of successfully selling the business, because it adds to the financing options potential buyers can leverage. While it is tempting to offer seller financing to accelerate the sale - and often increase price - there are some risks to keep in mind. What should you know before seller financing your business sale?
Here are six key considerations:
1. DO assess the risks. You will be tied to the business long after the sale is complete.
Unlike a cash sale where the seller can comfortably walk away from the business with money in the bank, when you finance your business sale, you remain 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. But if the new owner fails, you may suffer the loss of interest income and incur additional costs to collect the debt.
You can minimize risk by getting your business SBA approved, which can give potential buyers access to another financing option to offset some or all of the seller-financed portion.
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 you are comfortable enough to invest in the new owner, then it could be beneficial to finance the sale yourself. You’ll likely close the deal more quickly, receive a higher asking price and earn income from collected interest.
2. DO leverage the benefits of an interest-earning investment.
Your willingness to carry the note in a seller financed transaction is an interest- earning investment. If the buyer is a 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.
Right out of the gate, your 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 you can leverage your willingness to finance as a bargaining tool during negotiations.
Another 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. Remain firm on charging the amount of interest you feel is appropriate for the market and the level of risk you are assuming.
Finally, you may defer or reduce your tax liability. Collecting part of your business sale proceeds in installments that occur in future years means you spread out your taxable gains. This defers your tax liability, and may reduce the overall tax burden if you can prevent moving up tax brackets .
3. DO advertise seller financing when you list your business for sale.
Advertising seller financing in your business for sale listing can be a big plus that attracts more buyers. If you are comfortable with financing part of the sale, you should include that information as a selling point in your 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 your asking price. On BizBuySell, we see that listings including seller financing yield a materially higher volume of views and inquiries than those that don't. Many buyers specifically filter their searches to only show owner-financed businesses for sale, making it an important feature to highlight in your listing.
4. DON'T waive the down payment. A healthy down payment can minimize your risk.
Seller financing introduces risk. A healthy down payment can minimize your exposure by distributing an equal or greater amount of the risk to the buyer. Unlike home mortgage lenders, who routinely accept down payments as low as 5%, business loans necessitate a much higher upfront investment.
It's in your best interest to finance no more than 10-40% percent of the sale price. If you decide to finance more than that, you need to have a legitimate reason for doing so. For example, if you are selling the business to a family member, you may have a vested interest in financing an amount beyond the normal range.
As your financing commitment increases, so does your risk. Therefore, a higher interest rate (12-20%) is justified on any financing deals over 50% of the selling price.
5. DON'T do it yourself. Get legal and professional advice from someone you trust.
By definition, seller financed business for sale 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.
However, don't get too caught up in the do-it-yourself mentality. A loan between a seller and a buyer is subject to limitless structures and variations, many of which require the input of professionals in order to secure airtight collateral, coherent loan terms and adequate insurance coverage. Before you agree to financing, obtain legal and financial advice from professionals you trust.
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 you are 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 you aren't completely comfortable with financing the buyer's purchase, walk away and wait for a better buyer candidate to emerge. To learn more about seller financing, read ' What is Seller Financing for a Business'.