Deciding to sell your business is one of the most consequential decisions that you will likely ever make. Commercial transactions like these are significantly more complicated than purchasing or selling a piece of residential property, for example, and there are a lot of factors that go into a successful sale.
When you are looking to cash out of your business, you naturally want to get the highest price along with the most favorable terms and conditions. Ideally, this would mean bringing in a suitable buyer who could pay your entire asking price in cash. Buyers like these are few and far between, however, and most of them will need some type of financing in order to complete the deal.
When it comes to financing, many business owners wonder whether they should consider self-financing the deal, or if they should insist that the buyer comes up with all of the funds from outside sources. There are pros and cons with seller financing, but overall, it is definitely worth considering for many sellers.
Table of Contents
- How Does Seller Financing Work
- The Advantages of Seller Financing
- The Disadvantages of Seller Financing
- Speak with a Local Business Broker about Selling your Business
How Does Seller Financing Work
Seller financing typically works a bit differently from bank financing. Because the seller is risking far more than a bank would, they will want to thoroughly examine the buyer to ensure that this person is capable and has the proven ability to successfully run their business.
Another thing that is different is that the term of a seller-financed contract will typically only run from about 5 to 7 years, rather than 15 to 30 years through a conventional bank loan. There is also usually a balloon payment that is due at the end of the term to pay off the loan. The thinking is that 5 to 7 years should be plenty of time for a capable buyer to make the business profitable and be fully comfortable operating it.
A seller who is financing should require at least one-third of the purchase price as a down payment. They might also want to put some stipulations on where this money can come from (e.g., the buyer can receive this money as a gift, but they are not allowed to borrow it from a bank).
The buyer should always be able to come up with a significant portion of the down payment, so they have more of their own capital at risk and thus more incentive to keep the business viable. This also provides a good amount of upfront capital to the seller, which helps mitigate their downside.
The Advantages of Seller Financing
By far, the biggest advantage to offering seller financing is that it significantly widens the pool of potential buyers. As we talked about earlier, most buyers do not have hundreds of thousands of dollars lying around to invest in a business. Getting a bank loan is not always easy for those who want to purchase a business, so the money is going to have to come from somewhere else.
Cash deals are always nice, and if you are in a seller’s market, it might make sense to hold out for a deal like this. But on average, you are likely to sell your business for a significantly higher price if you offer self-financing. On top of this, you will be receiving interest on the payments, and you might also be able to mitigate some of your tax liability. Finally, buyers will be more confident that a business will succeed if the seller is willing to put their own money on the line by financing the purchase.
The Disadvantages of Seller Financing
Of course, there are some downsides to self-financing the sale of a business. The biggest disadvantage from the standpoint of most sellers is that they are unable to simply walk away from the business and not worry about it anymore. For whatever duration the loan ends up being, you as a seller are tied to the success or failure of the business. If the new owner defaults, you will need to go through the legal steps of taking the business back. And in a situation like this, the business that you take over will probably not be in the best of shape.
Because this is a potentially disastrous scenario, it is all the more important to fully vet your prospective buyer and make sure he/she has plenty of skin in the game. You should also have the sale contract drafted by a professional who understands the ins and outs of deals like these. For example, you should require the buyer to take out a life insurance policy to protect you financially in the event of a worst-case scenario. You should also have a clause that prevents the buyer from selling off any portion of the business before they have paid your loan in full.
Speak with a Local Business Broker about Selling your Business
Is this the right time to sell your business? If so, should you consider seller financing? Business owners can get answers to these and other important questions by consulting with a reputable business broker. CPA and accounting firm broker handle the sales and purchases of businesses, and they work closely with sellers to help them smoothly navigate the complexities of the process. This saves sellers a lot of headaches and helps ensure that they are able to bring their business sale to a successful conclusion.
