Buying and Selling a Business: The Pros and Cons of Seller Financing
During a business sale, one of the most important issues to address is financing. Most buyers do not have 100% cash to purchase the business outright, so they will need to find other sources to secure the funding they need. There are several potential financing options the buyer can look at. These include:
- Family and Friends
- Bank and SBA Loans
- Venture Capital/Angel Investors
- Seller Financing
The first three options may be challenging for many prospective buyers, particularly those who do not have a wealthy family member and/or those who have less than perfect credit. Selling financing offers an alternative that, in many cases, could be in the best interests of both the buyer and the seller.
Advantages of Seller Financing
For the buyer, seller financing has very little downside. The interest paid is typically similar to what they would pay through traditional financing, and they are likely to receive more favorable terms and conditions. In addition, when the seller finances part of the purchase, they maintain a vested interest in the success of the business, and may be much more willing to provide assistance to ensure the business continues to thrive.
There are some advantages for the seller as well, including:
Wider Pool of Buyers: Without seller financing, many prospective buyers might lack the financial wherewithal to purchase the business. By limiting the number of buyers, it may take longer to sell the business. On the other hand, by offering to finance part of the sale, you have a better chance to sell quickly and receive a higher price.
Easier for Buyer to Obtain Outside Financing: If the buyer is financing partially through a bank, and partially through the seller, banks are far more likely to look favorably at the loan application. If a bank sees that the sellers are carrying part of the loan themselves, it shows that they believe in the buyer and their ability to make the business work.
Seller Receives Interest: On top of the sales price, the seller is paid interest over a period of years. In many cases, the interest they are paid is higher than other investment options that carry the same level of risk.
Potential Tax Advantages: When the seller receives the entire purchase amount up front, it can throw them into a much higher tax bracket, forcing them to forfeit more of their hard-earned dollars to Uncle Sam. Financing over a period of years can keep your tax burden lower.
Disadvantages of Seller Financing
There are some potential downsides for sellers when they decide to finance part of a business purchase:
Increased Risk: The buyer may not know nearly as much about the business or industry as the seller. This means there is a chance they will mismanage the operation and default on the loan. If the loan is financed by the bank, that is not the seller’s problem. With seller financing, however, they are on the hook if the business fails. One way to alleviate this risk is to request a higher down payment and require the business assets as collateral.
Unfavorable Terms with Other Lenders: If the seller finances part of the purchase and the rest of the financing comes from a bank, the bank may ask for certain terms, such as being in “first place” on the loan in the event of a default, and requiring the seller to wait a certain period of time (typically up to two years) before the buyer starts making payments on the seller-financed portion. These issues must be taken into consideration before deciding if you want this type of arrangement.
Seller financing is an often-overlooked way to structure a business sale that can be advantageous for both parties involved. For the seller, it is important to ensure their interests are fully protected if they choose this option. For this reason, it is best to consult with a reputable business broker during the sales process. Business intermediaries have in-depth knowledge of seller financing, when to accept this option, and how to properly structure the transaction to your benefit.