Seller financing is an integral part of today’s business-for-sale marketplace. At BizBuySell.com, we estimate that roughly 90 percent of successful small business sales involve the owner financing a portion of the purchase price.
It’s challenging, but possible, for business buyers to find third-party financing. But in today’s banking climate, commercial lending restrictions can limit a buyer’s ability to make legitimate offers and close deals. So like it or not, there’s a good chance that seller financing will play a role in your planned business exit.
Seller Financing: Advantages and Drawbacks
Seller financing can help you reap financial and non-financial rewards from the sale of your company. The catch is that there are also some potential drawbacks and pitfalls–especially if you aren’t prepared to structure the deal in a way that protects your interests.
1. Speed of Sale
Seller financing can dramatically reduce the amount of time it takes to sell a small business. The current shortage of third-party capital for business acquisitions increases the appeal of seller-financed opportunities to buyers. So if you are willing to finance part of the sale, be sure to include the possibility of seller financing in the sale listing.
2. Purchase Price
It’s a given that seller-financed businesses command a higher purchase price than cash or commercially financed deals; they are more appealing to buyers and that results in a higher sales price. Although the market will ultimately dictate the purchase price, don’t be timid about leveraging your willingness to hold paper during negotiations.
3. Interest Income
Seller financing means that you will receive interest income above and beyond the actual purchase price. Although interest rates are usually indexed to current commercial rates, the added income is a nice perk for sellers who don’t need the entire sale proceeds upfront and can afford to stretch payment over a period of time.
4. Timing of Taxes
By accepting part of the purchase price of your small business over time via seller financing you spread out the financial gain over a longer time period. This means that your taxable income from the transaction is spread out over a longer period as well. Consult your tax adviser to understand the ins and outs of how this may affect your tax situation.
There’s no denying the fact that seller financing increases risk. To mitigate the impact of a buyer default, you should require a significant down payment (at least one-third of the purchase price) and hold business assets as collateral. If the buyer finances even part of the sale through a commercial lender, your risk will decrease–but the bank will probably hold first collateral position over the business and its assets.
2. Ongoing Connection
Most sellers want to make a clean break from their companies–a goal that simply isn’t compatible with seller financing. But even though it means you will remain connected to the business, willingness to finance part of the deal tells prospective buyers that you are confident in the company’s future viability.
3. Opportunity Cost
Assuming that you have taken appropriate measures to mitigate risk and protect your financial interests, the biggest downside to seller financing is that it limits your options after you exit the business. Since you won’t receive all sale proceeds upfront, you may not be able to reinvest in a new business venture or pursue other opportunities that require significant capital. Passing up those opportunities comes with a cost typically greater than what you recoup via the interest rate.
The decision to finance a portion of your business sale shouldn’t be taken lightly. Even under ideal circumstances, seller financing will have ramifications that can impact you and your family for years to come.
It’s also important to understand that a seller-financed deal is not a do-it-yourself transaction. To properly structure loan terms and secure airtight collateral, sellers are advised to enlist the help of qualified legal and financial advisers and/or qualified business brokers.