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Using Seller Financing for a Successful Business Sale
A few years ago, you may have been able to sell your business without needing to lend your buyer a chunk of change. Then, COVID-19 swooped in and upended the game.
In any crisis, including the pandemic that began in 2020, commercial lenders receiving financing requests get notoriously tight-fisted. With bank loans for small business purchases now harder to come by, your deal structure may require up to 20% in seller financing.
Typically, your lending term might be two to four years, meaning you’ll have to wait patiently to recoup the full amount of the sale price. But they say patience is a virtue—and let’s not overlook the fact that seller financing a business brings you several worthwhile advantages.
Let’s look at the bright side of seller financing, and also get clear on how it works.
Did You Know...
Seller financing bridges the gap between the sale price and the buyer’s ability to finance.
Pros of Seller Financing a Business
Also known as vendor financing, seller financing aligns your buyer’s interests with your own.
When you finance part of the deal, you signal to your buyer and his or her lender that you’re comfortable enough with the business to shoulder part of the transition risk. With that assurance, the commercial loan officer is more likely to smile upon the buyer’s financing request and you’re more likely to get the sale.
Seller financing bridges the gap between the sale price and the buyer’s ability to finance. Without your contribution, your buyer may have trouble scraping up the full amount from other sources—or may be reluctant to do so given the riskiness of any new business venture.
When you provide seller financing, here are some ways you’ll benefit:
- Sell for more money. Because your buyer will take on less risk, he or she may be willing to pay more.
- Improve your odds of selling. When you offer seller financing (as well as follow other steps to increase your chances of selling), you’ll get more inquiries from interested buyers, which in turn will generate more offers. The last thing you want is for your listing to languish.
- Reduce your taxes. Getting less cash on closing is not all bad. For one thing, it will defer some of your tax liability to future years.
- Charge interest. Did you know you can charge your buyer a higher interest rate than you might receive if the money were to sit in your account at your financial institution? The interest you’ll earn will boost your overall cash flow.
Remember to put yourself in the buyer’s shoes, as forgetting to do so can kill any deal. So, what does your buyer get out of seller financing?
First of all, your buyer will sleep easier knowing the purchase is less risky. Second, the money you lend shows you have confidence in the buyer’s ability to succeed. And third, in the buyer’s eyes, you now have an incentive to help out during the transition to new ownership.
And look at it this way: if you shy away from financing the sale, what does this say to your buyer? That you’re looking to jump from a sinking ship? Show the buyer you have faith in your business by offering seller financing.
Cons of Seller Financing a Business
Besides getting less cash up front, what are the disadvantages of seller financing a business?
Obviously, you’ll be taking a risk. If for any reason the buyer isn’t able to pay, you may need to take legal action to recoup your losses. In some cases, you might even have to take back the business.
Seller Financing a Business: How Does It Work?
Seller financing comes in three basic forms:
- Debt, also known as a seller note, a vendor note, or a vendor take back: The buyer will pay in installments, usually in the form of fixed monthly amounts.
- Contingent debt, also known as a seller earnout: Future payments will depend on one of the following or both: the business’s performance, or your own performance if you serve as an advisor during the transition.
- Equity: If your company is incorporated, you might agree to sell your buyer a majority of the business’s shares right away and the remaining shares over time.
Whatever form your financing takes, be sure to conduct due diligence on your buyer. Check his or her credit report and financial history. In some cases, you may also be able to ask your buyer for a personal guarantee.
Always ensure your seller financing is well documented and reviewed by a lawyer who’s familiar with business transactions.
Final Thoughts
Whether you’re selling in Toronto, in the GTA, or elsewhere in Ontario, a Certified Exit Planning Advisor (CEPA) and seasoned business broker at Transitions Business Brokers can help you create and implement a solid exit strategy. We can also help you structure the right deal to sell on your desired timetable, on your own terms, without leaving money on the table.
Transition into your next stage of life feeling prepared and confident! Engage the Transitions Specialists today.
Transitions Business Brokers
June 15, 2023
