What is Business Seller Financing?
Seller Financing can help get deals done! Financial expert John Davies explains the Pros and Cons and the reasons why Sellers may want to consider this option.
Business seller financing occurs when the business owner acts as the buyer’s lender to cover a portion of the purchase price. In return for the loan, the buyer signs a promissory note, which includes pertinent information such as interest rates, default penalties, and more. Determine if business seller financing is right for you with help from Sunbelt Business Brokers.
Pros of Seller Financing
Due to the risk associated with seller financing, many sellers are often reluctant to offer it. If sufficient research is done on both the seller and buyer sides, seller financing can be beneficial for all parties involved.
Advantages of business seller financing for the seller include:
- Increased selling price
- Attracting larger pool of serious buyers
- Earning regular interest payments in addition to down payment
- Decreased income taxes
- Increased likelihood of sale
Some buyers won’t even consider looking at a business unless seller financing is available. With more buyers interested in the business and able to purchase it, sellers are able to increase the price, as well as the likelihood of a sale. Add the principal amount plus interest payments to the sale and seller financing is looking fairly profitable for the seller.
Advantages of business seller financing for the buyer include:
- Peace of mind knowing seller believes in future of business
- Affordable monthly payments
- Ability to buy businesses without traditional bank loans
For buyers, seller financing is a fantastic opportunity to purchase a business that he or she may not otherwise be able to purchase due to traditional bank loan qualifications. In addition to affordable monthly payments, the buyer benefits from the seller continuing to have an interest in the business. If the buyer needs guidance or advice, the seller is going to be compelled to help because his or her money is also at stake.
Cons of Seller Financing
The pros of seller financing certainly outweigh the cons, but there are several important issues to keep in mind when considering seller financing.
Disadvantages of seller financing for the seller include:
- Increased risk
- Continued involvement in business
- Less capital immediately
To ensure payment from the buyer, sellers should check the buyer’s credit score and personal finances, as well as request collateral and a personal guarantee. In addition to risk, the seller is forced to have continued interest in the business, which could be a negative if he or she wanted a clean break. Lastly, because the buyer isn’t paying in whole upfront, the seller receives less immediate capital.
Disadvantages of seller financing for the buyer include
- Monthly payments
- Balloon payment
For the buyer, there are few disadvantages to seller financing. Anytime you buy a business, you are taking a risk; however, the risk for seller financing is not much different than the risk associated with other financing options.
Seller Financing Taxes
In addition to the benefits listed above, business seller financing allows the seller to save on income taxes. Because the buyer is paying in installments rather than a lump sum payment, the seller’s taxable income is spread out over time. Smaller payments mean smaller taxes.
One thing sellers may not consider in regards to taxes is the interest rate. The seller should be sure to collect a fair rate of interest on monthly payments due to imputed earnings. Imputed earnings allow the IRS to estimate how much you have earned on interest payments and tax you based on that estimate.
While it might be tempting to lower taxes by spreading payments out, keep in mind the fees associated with selling your business. You’ll want to be sure that the down payment is sizable enough to cover all expenses.
Business Seller Financing Contracts
Business seller financing contracts protect the interests of both the buyer and seller. To ensure all paperwork and agreements are drafted and signed properly, it is best to work with an experienced attorney. Below are some of the key documents that should be included in the contract, as well as links to examples. Be sure to include:
- Letter of Intent: Sets expectations for negotiation
- Deal Contract: Describes the terms of the sale
- Promissory Notes: Establishes terms of loan and repayment
- Security Agreement: Lists assets that will be used as promise of payment
- Uniform Commercial Code Financing Statement (UCC-1): Recorded with Secretary of State in state of business to secure seller’s interest in collateral
- New Lease for Commercial Space: Contact your landlord to discuss terms
- Transfer Documents for Vehicles: Contact your local Department of Motor Vehicles for proper procedures
- Bill of Sale: Proves sale of business.
- Non-compete Agreement: Prevents seller from competing against business.
- Bulk Sale Documents: Record sale of business inventory
- IRS Form 8594: Specifies allocation of purchase and assets for tax return purposes
- Consultation/Employment Agreement: Documentation to keep seller working with company after purchase
Business Financing Guidance
Overall, business seller financing can be a great financing option for both buyers and sellers; however, there are risks involved in all types of business financing. If you’re looking for a professional to discuss the right type of financing for your business sale or business purchase, contact your local Sunbelt Business Brokers office. Our brokers have the industry knowledge and expertise to help you sell or buy a business using the financing option that best suits you.
After obtaining his MBA, John began his career at PriceWaterhouseCoopers, the international accounting and consulting firm, and subsequently joined Progressive Corporation, a large U.S. based insurance company. John was a Division President at Progressive and subsequently became the CEO of a New York based private equity investment company. In 2001, he founded MMI as a platform investment company and MMI has subsequently acquired 15 additional companies.