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What Is Seller Financing for Business and How Does It Work?

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Content was accurate at the time of publication.

Seller financing for business is an arrangement in which the seller of a business provides a loan to the buyer to enable them to purchase the business. The buyer then pays back the seller in installments, with interest. The buyer usually contributes a substantial portion toward the sale, though in some cases the seller may finance 100% of the asking price that remains after the buyer has contributed a down payment.

What is seller financing for business?

Also known as owner financing or seller carryback, seller financing opens up doors for both buyers and sellers. The seller offers a loan that can finance all or part of the business’s purchase price, which means that a buyer who may struggle with finding other financing sources can still become the business owner.

Seller financing for business is also good for the seller. When you hang a “business for sale by owner” sign in your window, there’s no guarantee a good buyer will come along. If you offer owner financing, you can make that probability far greater, expanding your potential pool of offers for your business.

How does seller financing work?

Seller financing requires:

  • An asset purchase agreement, which outlines the terms of the sale, including the sale amount and any seller financing that’s involved
  • A promissory note signed by the buyer
  • A personal guarantee

In some cases, you’ll also need a collateral agreement, which could put UCC-1 liens on the buyer’s business equipment. These agreements can be a prerequisite to seller financing since they give the seller needed protection.

The buyer will also have to provide a recent credit report. Their credit score must be good because most sellers require a score of at least 700 to sign a seller financing contract. The buyer must also provide a verifiable financial statement.

It’s a good idea to have a lawyer advise on how to structure a seller financing deal and draw up the paperwork. The closing should be done in the office of a title company or attorney since all seller financing agreements must be notarized.

Seller financing terms

Seller financing terms are usually negotiable, including down payments, interest rates, term lengths and monthly payments. This flexibility means that seller financing can be a fit for many sellers and buyers, which is why the practice is so common in business sales.

“Most small business transactions don’t happen without some element of seller financing,” said Dustin Zeher, principal broker at Horizon Business Brokers in Tysons Corner, Va. “In the transactions [we’ve] done over the past 15 years, we have seen that most … have about 20% of the sale price being financed by the seller.”

Zeher said he believes it’s a good policy to have the buyer and seller contribute even amounts to the transaction. “I would advise a seller to protect their interests … and [not] offer more than 50% seller financing so there is an equal vested interest.” Though, he noted it’s not uncommon to see upward of 80% to 100% of the sale price financed by the seller.

Seller financing pros and cons for buyers

Pro: Ability to purchase when other financing fails

A buyer who has trouble getting traditional financing to buy a business may be able to get funding from the seller, allowing them to purchase it when they wouldn’t have been able to afford it otherwise.

Pro: Security and confidence

The buyer can feel secure in knowing that a seller offering seller financing is very confident that the business will generate sufficient cash flow to help the buyer repay the loan.

Pro: Higher return on investment

Buyers get a higher return on their investment from a cash-on-cash standpoint when they use seller financing, especially with larger transactions, Zeher advised. This frees up cash for them to invest in other opportunities.

Con: Transition challenges

The seller may provide training to put the buyer in a position to succeed at running the business. But if this training is insufficient or unhelpful, the buyer could struggle to get up to speed quickly — and the business could falter.

Con: Management interruptions

If the seller isn’t quite ready to hand over the reins to the business or disapproves of how the buyer is running it, they may feel inclined to interfere in daily operations. This can be distracting, frustrating and dispiriting for the buyer.

Seller financing pros and cons for sellers

Pro: Better sales price

Buyers receiving seller financing may be able to afford to pay more for a business, so they could be willing to offer a price that is close to or even higher than the asking price.

Pro: Reduced tax liability

Seller financing can help reduce tax liability associated with the sale of the business. Sales involving financing are considered installment sales, with capital gains taxes to be paid over the course of the contract.

Pro: Expanded buyer pool

Offering financing is a way for a seller to demonstrate faith in their business, which has the effect of expanding the buyer pool — potentially substantially — as buyers gain confidence.

Con: Missed investments

When the seller doesn’t receive all the cash upfront from the sale of the business, they don’t have that money to invest elsewhere, which could cause them to lose out on good financial opportunities.

Con: Risk

If the business doesn’t do well after the sale, the situation may require a lien or a clawback, and then the seller would have to run the business despite getting out of it. If the buyer profoundly mismanaged the business, the seller then would have to go through a foreclosure.

If a buyer defaults on the loan and the seller doesn’t have the proper protections in place, the seller will lose that money with no ability to recoup the loss.

“If the buyer has any problems running the company, the seller will be returning the phone calls and may need to come back to work to help get their seller note paid,” said Todd C. Cushing, principal at EBIT Associates in Lake Forest, Ill.

How to find additional funding to complete a seller financing deal

Seller financing doesn’t often cover the entire purchase cost, so a buyer may need to find additional sources of financing to buy a business. Some options include:

Rollovers as Business Startups (ROBS)

A ROBS is a way for a business owner to tap into their retirement funds to finance startup costs for a business. The arrangement involves rolling one’s retirement funds to a ROBS plan — a tax-free transaction — and then using the money to start or buy a business.

SBA loans

The Small Business Administration (SBA) works with a network of financial institution partners across the U.S. to provide loans to small businesses, especially those that can’t get funding from traditional financing sources. A credit score of 680 will give you a better likelihood of being approved, but some types of SBA loans have lower minimum credit score requirements.

Bank loans

Traditional business loans can be reliable for many borrowers, although you may have to have a certain credit score to qualify. Traditional banks often look for borrowers to have a credit score of at least 650, though they’re more likely to lend to those with scores of 680 and higher. The higher your credit score, the better your borrowing terms will be. Bank loans may be more difficult for newer business owners to access.

Home equity lines of credit (HELOCs)

With home equity lines of credit, you borrow against the equity in your home. A HELOC is a line of credit. There is a draw period and then a repayment period. A HELOC could be a good option for those who have paid off a decent portion of their mortgage.

Seller financing FAQ

Where can I find seller financing business contract templates?

You can find seller financing contract templates on a variety of websites. Some provide free templates, while others may charge for access. Try these to start:

What do I need to know about my seller financing promissory note?

A seller financing promissory note outlines how much the buyer will pay to the seller, including the total number of payments and when they will be due, as well as what occurs if the buyer defaults on payment. This is a legally binding way to define seller financing and how it will take place.

Is seller financing for business right for buyers and sellers?

Seller financing can benefit the buyer by opening up purchase options that they couldn’t otherwise afford. It can also help the seller by broadening the range of potential buyers. However, there are pitfalls to seller financing for both the buyer (transition challenges) and the seller (risk). Seller financing won’t be right for every buyer or seller, so assess your situation.

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