Seller financing, also known as owner financing, is an alternative financing arrangement used in the sale of a business, where the seller extends credit to the buyer to purchase the business. Instead of the buyer securing a loan from a traditional financial institution, the seller acts as the bank, allowing the buyer to make payments over time. This method can be advantageous for both parties involved. For sellers, it opens up the buyer pool to those who may not qualify for traditional loans, potentially leading to a quicker sale. For buyers, it offers more flexibility in negotiation terms and may allow for a smoother transition, as the seller often remains involved in the business during the transition period to ensure success.
Seller financing is not without its risks, however. Sellers must assess the buyer’s creditworthiness and may require collateral to secure the loan. Additionally, if the buyer defaults, reclaiming the business could be a complex and costly process. Despite these risks, seller financing remains a popular option due to the mutual benefits it offers, facilitating deals that might not otherwise be possible through conventional lending channels.
Benefits of Seller Financing:
Increase Buyer Interest
Sellers may have more flexibility with financing requirements, making business ownership more accessible to buyers. If you’re selling your business, you likely want a quick process. By offering financing, buyers can quickly fund the purchase and mix financing methods, improving their chances of reaching the price. This also shows confidence in the business’s success, as repayment may link to its cash flow.
Faster closing times
Seller financing offers speed by bypassing lengthy bank approval processes. Approval can be as quick as the seller’s decision post buyer information review. In contrast, traditional bank financing aligns with the bank’s schedule, often taking months due to rigorous buyer vetting. Seller financing allows for rapid progression, potentially closing deals in weeks. Upon seller approval and mutual contract agreement, the transaction concludes swiftly.
Note: Sellers should not feel pressured to rush just because they can. It’s crucial to dedicate time to carefully assess a potential buyer’s financial and professional background as a key part of choosing the best buyer. Learn more on how long it takes to sell a business.
Higher Sales Price
As you control the financing amount, you can request a higher purchase price for your business without impacting the timeline or approval process. Additionally, sellers will earn interest on the loan amount they would otherwise miss out on.
Interest payments can turn seller financing into a profitable investment
By offering financing for your business sale, you can earn interest to reinvest in future deals or for personal use. This can boost your business’s value through interest payments from the buyer. Seller financing rates typically range from 6 to 10 percent, potentially accumulating a substantial sum over the years. Collaborate with your business broker, accountant and attorney to determine a suitable rate for a beneficial transaction.
Tax benefits
When opting for seller financing, sellers receive monthly payments spread out over months or years for their business. This approach offers tax advantages by reporting gradual gains instead of one large sum, leading to lower income taxes. Seller financing might not be suitable for business owners seeking an upfront cash lump sum. Instead of a single payment, buyers make installment payments over time, with many sellers requiring a larger down payment (15 – 20 percent). Receiving payments in installments can be more tax-efficient, enabling sellers to retain more earnings from the sale..
Downsides of Seller Financing:
Seller financing can expand the range of prospective buyers
Selling a business presents a major challenge: finding the perfect buyer. Some potential buyers may not meet the criteria for financing from conventional lenders. Traditional bank financing, in particular, comes with stringent approval conditions, such as those for business loans.
Seller financing opens up opportunities for more buyers to consider purchasing the business. However, sorting through numerous potential buyers can complicate the process of identifying those most likely to repay the financing, especially if you lack experience in this type of due diligence.
There isn’t a clear separation with seller financing
Certain entrepreneurs might aim to finalize a deal, offload their business, and swiftly transition. However, seller financing complicates this, as the seller remains linked to the business’s future success to receive continual payments. Consequently, those providing financing often discover themselves bound to the business post-transaction.
Seller financing might demand additional effort from the seller
Seller financing empowers current business owners to choose their business successor, yet it entails added responsibilities. In contrast to conventional financing where a bank assesses funding eligibility, in seller financing, the owner must determine both the funding qualification and the candidate’s capacity to effectively manage the business. Consequently, sellers often invest significant time assessing applications to identify the ideal buyer.
Risk of Buyer Default
If the buyer fails to pay, you will have to reclaim the business, including repossessing the lease. Dealing with that could be a hassle you’d prefer to avoid.
It’s easy to feel overwhelmed with all of the steps, negotiations, and documentation involved in the business selling process. To get the best results, it’s important to work with a business broker in the process as soon as you possibly can. The Jacksonville Business Broker brings two decades experience in successful business sales and M&A experience. Contact John Geiwitz for a complementary business consultation.
