Seller Financing: What Buyers and Sellers Should Know

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Seller Financing: What Buyers and Sellers Should KnowOne of the effects of rising interest rates, and worse, bank failures, is a move towards alternative forms of financing for business transactions. As interest rates rise in coming months, more clients will be looking at seller financing as a larger part of a transaction, rather than a pro forma aspect of a traditional SBA loan. Let’s examine what buyers and sellers should know about seller financing.

Sellers

Some sellers offer seller financing as an option because they can’t get bank-financed deals. They haven’t kept clean books, or as we’ve heard once, they “don’t feel the need to involve the IRS in my cash business.” We don’t get involved in those sorts of businesses because we often find that the business isn’t really healthy enough to sell anyway.

There are four main draws for sellers to offer to finance their own sale:

  • Deferred taxation: instead of incurring a one-time liquidity event tax, they will be taxed annually at the capital gains rate on only the payments they have received that year
  • Higher premium: seller-financed businesses are known to sell at a premium above all cash deals
  • Faster sale: seller-financed deals involve a larger buyer pool, driving both the number and velocity of offers
  • Better rates: sellers might be able to get better terms for their money in a seller-financed deal than they can in the general marketplace

For sellers who are ready to sell but are neither anxious about the ongoing success of the business nor need a large payout, seller financing can be a solid option, even during times of great market and bank certainty.

Buyers

Since there is no third party involved in the financing of the deal, sellers have to scrutinize buyers more closely. This can involve:

  • Pulling a credit report
  • Doing a background check
  • Interviewing references not only for character but for business experience, particularly in the industry
  • Examining the business plan
  • Hiring a private investigator

While the last one might seem a bit serious, it’s a small investment to “trust, but verify” on what will be an important transaction in your life.

Buyer and Seller Expectations

Here are some reasonable expectations that both buyers and sellers should prepare for:

  • Sellers may want to maintain access to financial statements for the duration of the deal; their money is tied up with the success of the business, and they have a reasonable right to monitor the situation.
  • Sellers will want to create strong promissory notes with clear clauses for non-payment and late payments and should consider a general lien on the business for the duration of the note.
  • Sellers may demand a significant down payment, sometimes as much as 50% of the deal and will offer repayment periods between 3-7 years.
  • Buyers should remember that seller financing isn’t a forever situation: as market conditions improve and they are able to establish a clear financial history for the business, they may be able to obtain traditional bank financing during the term of the seller-financed note and pay it off early.

We’ve been around a long time at Apex and we have experienced times when banks weren’t even returning calls! Being familiar with seller financing before you need it only strengthens your position if it ends up being a significant part of your transaction.

Are you interested in offering seller financing for your business? Give us a call.