What is Seller Financing for a Business?

With a large amount of business deals involving seller financing in one way or another, it should come as no surprise that it offers a number of benefits for buyers and sellers alike. But what exactly is seller financing for a business, and does it make sense for your particular situation?

What is seller financing for a business?

Quite simply, seller financing for a business acquisition involves the seller lending part of the sale fee to the buyer. This effectively takes the form of a loan, with interest rates, penalties, and terms determined by the seller.

You may have heard seller financing referred to by a different term. ‘Owner financing’ and ‘seller carrybacking’ refer to exactly the same practice. While prevalent in business deals, you may also find seller financing deals on properties or even vehicle purchases.

How does seller financing work?

A seller will typically look to lend somewhere between 10% and 60% of the sale price, though as they’re the ones deciding the details of the deal, this could be any percentage. Likewise, interest rates can vary wildly too but expect this to be more than you would expect to pay from a bank loan. Interest rates of up to 10% are not uncommon.

The buyer usually needs to provide a promissory note and personal guarantee to secure seller finance, but again, as the seller determines the terms, they may require more or less than this.

What benefits does seller financing hold for sellers?

Using seller financing as part of your sales strategy is a sound idea. By opening up the ability to purchase your business to those without sufficient liquid capital and those struggling to secure a traditional loan, you’re able to attract a much broader target market. This not only provides you with a better chance of selling, but also, a better chance to secure the best price

The increased field of potential buyers isn’t the only factor that can help you to secure a better price for your business. Acquisitions that involve seller financing are less likely to involve hard negotiations. By providing a means to buy your company, you can even ask for more than the actual asking price.

Owners can also benefit from some tax advantages by not receiving the acquisition fee in one lump sum. Instead, the payments can come in with a frequency of your own choosing, and spreads the fee across several years’ Capital Gains Tax allowances (currently set at £3,000 per year).

Drawbacks of seller financing for sellers

There is inherently more risk in selling a business this way. Without the resources of the big banks behind you to chase down debts, it can be difficult to get non-payers to cough up money that’s owed. Of course, those that have completed their due diligence with their contracts should have sufficient protections in place to avoid this.

Despite the tax benefits of being paid in instalments, many would probably prefer to be paid in full for their business. Once paid, you can make a clean break and move on to other ventures. With seller financing, that isn’t the case. Should the buyer not keep up with their payments, you may well end up running the business again, perhaps with the company having a worse standing than before.

Without the full amount paid, you may not be able to pursue other business opportunities either. If you’re using your business sale as a springboard toward investing elsewhere, then seller financing may not be the right option for you.

What benefits can buyers expect from seller financing for a business?

Seller financing can open up opportunities to purchase far more expensive businesses than you may otherwise be able to buy. It also allows those that would struggle to secure sufficient funding from a traditional lender a chance to buy a business.

By only putting down a fraction of the full sale price, you may also be able to afford to make the necessary changes to a new acquisition that you need. Similarly, it can allow you to start your tenure in charge of a new company with a more comfortable pot of cash reserves. Embarking upon any new venture can be daunting, and the more safety nets you have available to you the better.

On that note, the very fact that the seller is happy for you to pay them back over the course of a matter of years (as is often the case) should ease any anxieties that you may have been sold a sinking ship. After all, any seller is unlikely to accept payment in instalments if they had any worries that the business might not survive the payment term.

What drawbacks do buyers experience when buying a business with seller financing?

As you might expect with any scenario in which you pay for goods over a long term, you’re likely to pay more than you would paying up front. Not only that, but sellers that offer financing often inflate their prices as a result of providing such a service.

Buyers should also go over any contract with a fine-tooth comb. As seller-financed deals have terms drawn up by the buyer, there could be aspects to the loan that you haven’t expected.

You may also be expected to place a personal guarantee against your loan by some sellers. If your credit score isn’t great and you don’t have a lot of experience in running successful businesses, sellers will be looking for some peace of mind before offering finance, and that can come in the form of your home or other assets.

Can I buy a business with 100% seller financing?

In theory, yes. It’s possible to buy a business with 100% seller financing. In reality, however, you’re unlikely to come across such deals.

In practice, most seller financing covers between 10% and 60% of the agreed sale price. Sellers can sometimes be convinced to offer a larger percentage if a considerable down payment has been put down though. If you can stretch to an initial payment of 20% or more of the purchase price, some sellers may offer to cover the rest in seller finance.

What does a typical seller-financed deal look like?

It’s difficult to describe a ‘typical’ example of a seller-financed deal, as each seller will have their own requirements. The following, however, should provide some idea of what you can expect.

Usually, seller financing requires a down payment of at least 10%. After that, they may decide to cover any percentage of the remaining balance, but this is typically between 10% and 60%.

Interest rates will depend on multiple factors, but if buyers have been unable to secure finance elsewhere, the seller will often offer a high rate due to there being no other options for the buyer to take. Rates between 7% and 10% are not uncommon.

Repayment terms will be discussed between both parties, but five or six years seem to be a popular choice for many. Longer terms can be offered, but keep in mind that sellers can see their sale value eroded by inflation if buyers are afforded too long to pay.

Is seller financing right for you?

As a seller, you need to make sure that you’re happy to receive the money over a longer period of time. If you’re in need of significant funds straightaway, you will be better off looking at different sales packages.

However, if you’re happy to receive the fee in instalments, then you can potentially receive far more money than a standard deal thanks to the increased buyer field, potentially higher prices, and the interest you make on the buyer’s payments. Not only that, but you can generally complete a seller-financed deal far quicker than other business sales.

As a buyer, there are relatively few downsides to seller financing for a business. The main drawback is the potentially higher rate of interest than you may have otherwise secured from a bank. However, for those struggling to secure a traditional loan, seller financing can make the acquisition of certain businesses a reality.

Looking for assistance with seller financing for a business?

Seller financing can be a useful business sales method for buyers and sellers alike. To ensure that everything is set up as it should be though, it’s highly recommended that a professional third party is involved.

We have specialists on hand that can help you to not only set up seller financing for a business, but also sell or buy a business in the first place. Call us on 0800 975 0380, or email [email protected] for a free consultation.