A Buyer’s Introduction to Seller Financing
With inflation and interest rates on the rise, the number of opportunities open to many small business buyers seems to be shrinking. Access to traditional forms of financing is tightening, and their dollar isn’t as valuable as it used to be.
Fortunately, there are more creative ways to structure a business purchase that might deliver far better value. One useful tool is seller financing.
Seller financing refers to an arrangement where the buyer pays a portion of the sale price back to the seller, with interest, over an extended period of time. Essentially, the seller acts as a lender, like a bank, but often with less onerous requirements for the buyer. Even in 2018, Guidant Financial reported that between 60% and 90% of small business transactions involved seller financing. In the current market environment, that figure has likely risen.
If you’re a seller, we previously highlighted three tips to keep in mind when offering financing. There are, after all, benefits for sellers too. According to expert, the businesses offering seller financing are more likely to sell, sell with fewer delays, and command a higher sale price. Plus, it creates long term income for the seller that comes with tax benefits.
If you’re a buyer, seller financing indicates that the seller is confident in the future of their business — that it will continue to generate enough money for you to pay off the business plus interest. According to Guidant, down payments and interest rates (usually 6% to 10%) are lower compared to traditional lenders, and you as a buyer tend to have room to negotiate.
Here is the process you’ll typically go through as a buyer, as outlined by Entrepreneur magazine.
1. Come to terms
Set the terms of the agreement including the down payment, the interest rate, the term over which the financing will be paid back, and collateral. Typically, the business serves as the collateral, meaning the business goes back to the seller if the buyer defaults, but if your credit rating is suffering, the seller may request additional collateral in the form of property or other assets.
2. Make a down payment
Once you’ve agreed on the terms, you will have to put down about 25% to 30% of the purchase price. As we’ve outlined in this previous blog post, that money doesn’t always have to come out of your pocket, but whether it comes from your savings, an external investor, a lender or elsewhere, you should consult a financial and legal expert to help you structure the deal.
3. File a promissory
This is a legally binding document that you, as the buyer, will have to sign so the seller can enforce the terms of the repayment plan. It is often the buyer’s responsibility to do the administrative legwork to ensure this is filed.
4. Make regular payments
As per the terms of your contract.
5. Final balloon payment
This is typically a final lump sum to close out the debt. The amount will be determined by the size of your regular payments, the performance of your business, and any other relevant terms of your contract. Because seller financing terms are shorter than other financing arrangements (usually less than 10 years), a final balloon payment tends to be a standard part of the arrangement.
After that, congratulations, you own your business outright.
Opinions expressed here by contributors are their own.
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