Seller financing basics

Seller-financed small business sales are more common than ever these days and can be beneficial for sellers and buyers alike. Financing may allow sellers to benefit from a greater number of potential buyers and a quicker sale, while providing buyers with an additional incentive to buy.

Seller financing demonstrates that the seller is confident that the business has the potential for long-term profit, which will enable the buyer to pay off their loan. Additionally, banks view seller financing as buyer equity and may be willing to lend more money in a seller-financed transaction.

What Is Seller Financing?

Small business sellers offering seller financing allow the buyer to pay off a portion of the business’ price over time, with interest. A promissory note is drawn up, outlining the sale’s terms of use, including a schedule of payments and interest to be paid. It’s similar to a bank loan, but with the seller acting as the bank. The interest rate is usually the same or lower than bank prime rates, while the term tends to be about the same.

Generally, small business sellers finance a third or more of their sale price. The buyer typically makes monthly payments to the seller starting a month after the sale date, unless seasonal sales fluctuations affect the business to the extent that they would be reflected in the payment schedule.

Why Should Sellers Offer Financing

In a US 2014 nationwide survey of business brokers, nearly half said that over 60% of their closed sales included seller financing. That in itself is an incentive for sellers to consider financing in order to stay competitive in the market.

Many small business sellers offer financing in order to widen their scope of potential buyers, which may in turn reduce the time that their business is on the market, but there are additional benefits to financing your business sale.

Financing your sale allows you to set a higher sale price than you would with a cash sale. This is partly due to a greater demand for seller-financed businesses for sale, but also because the seller can set a slightly higher asking price to help offset the risk of financing.

In addition to setting a higher initial selling price, seller financing brings in profit from collected interest and allows you to spread out the taxable income from your sale over time. It also takes less time to clear than commercial financing, and since banks can require quite a bit of time to approve a loan, this may contribute to a quicker sale.

Seller Financing Considerations

If you decide to finance your sale, it’s important to make that apparent in your business-for-sale ad in order to attract a greater range of potential buyers, since many buyers may be filtering their search results to show only seller-financed businesses for sale.

Of course, there is some degree of risk involved with financing your sale. Requiring a down payment of at least a third of the purchase price and asking the assistance of a financial adviser or business broker to establish a contract with clearly defined loan-security measures can help to reduce the risk.

The type of loan security required for seller financing varies from seller to seller. Loan security can range from a personal guaranty from the buyer and his or her spouse that if payments are not made according to the promissory note, the seller may foreclose on the business, to specific collateral in the form of mortgages and security agreements on personal property, to stock pledges in which a corporation is formed giving the seller voting rights within the company so he can act in his own interest should the buyer default on payments. Seek professional help to ensure that your collateral is secure and your contract airtight.

Another thing to consider is that if you finance your sale, you’ll be connected to your company after you sell it up until the time that it’s paid off. When a new venture presents itself to you, your future opportunities may be limited if your capital is tied up in your old business.

On the other hand, providing financing may be beneficial if you want to stay involved in your business to some degree in order to ensure that it fairs well in the future. Seller-financed business sales require that the seller and buyer work together to some extent, potentially creating a positive relationship to help smooth the business transition.

Seller financing is not something to be entered into lightly, but after careful consideration of its future ramifications and consultation with legal and/or business professionals, you may find it to be the best choice for you.