A guide to seller financing

What is it?

Also called vendor financing, seller financing is a loan given by the seller of a business to its purchaser, usually on terms not dissimilar to those of a bank loan. 

As with a bank-financed acquisition the seller will generally pay some sort of down payment, paying off the rest in instalments, usually on a monthly basis, over a specified time.

What happens if the buyer defaults?

The same as if the buyer defaulted on a bank loan: the business is repossessed or foreclosed.

How do both parties protect themselves?

The terms of the deal are stipulated in a legally binding purchase agreement, which is drawn up with the help of an attorney and signed by both parties.

In what circumstances is seller financing generally used?

Usually when the buyer is unable to raise finance from the bank, whether because of a poor credit history or because the bank sees the business as a risky investment.

With bank finance still hard to come by, seller financing has arguably a more invaluable means of financing business sales than ever.

So seller financing can help finance a deal for a struggling business? 

Yes, although if the business is repossessed before the repayment period is up then the seller won’t get all their money. If your business has a patchy profit-and-loss history but you are confident of its potential to grow and have faith in the buyer’s qualifications – then seller financing is  ideal.

The very fact that a seller is willing to stake the receipt of the asking price on the future success of the business demonstrates confidence in the business and faith in the buyer

The very fact that a seller is willing to stake the receipt of the asking price on the future success of the business demonstrates confidence in the business and faith in the buyer. Duly reassured, a buyer will often therefore be willing to pay a higher price and interest rate than otherwise would have been the case.

The seller can also enjoy a greater yield by getting equity with interest, while the property can be sold in its present state without need for repairs.

Any drawbacks if you are selling your business using this form of finance?

Well if you need access to most or all of the asking price immediately then seller financing isn’t really going to work for you.

You might not get your money back at all. Seller financing can rescue deals for businesses that banks have dismissed as too risky, so the chances are your business is far from a Sure Thing.

Moreover, it’s more difficult for the seller to get a complete picture of the buyer’s credit and employment history, which ratchets up the risk further. 

Sell to the wrong buyer and the business can quickly lose customers and see costs soar, with the value consequently plummeting. If you take over the business in the event of default it could be a hard slog restoring its fortunes and dispiriting to return to the process of finding a buyer.

By contrast, with a transaction financed by conventional means the seller gets their money immediately and does not bear the risk if the business were to fail.

How can you minimise the risk?

Just as the buyer will conduct due diligence on your business, you need to be sure the buyer is right for your business. Many sellers care about the fortunes of their business post-sale for legacy reasons, but if you’ve financed the deal from your own pocket then there is a more hard-headed incentive to consider the buyer’s qualifications to run the business.

To give yourself the best chance of getting your money, you must be confident that the buyer is trustworthy, diligent and has the right experience and attributes to run your business successfully. 

What about the benefits to buyers of seller financing?

As aforementioned, the very offer of seller financing lends credibility to the seller’s claims about the business’s merits and potential, and no one knows more about the business than the current owner.

Buyers needn’t qualify with a loan underwriter either.

Are there any advantages that apply to both parties?

Providing both parties agree, complete flexibility of repayment terms. Furthermore, both parties can make considerable savings in closing costs and no PMI insurance premiums are required unless negotiated.