Whether you’re a business owner looking to sell your firm or a budding entrepreneur looking to acquire a business, the common denominator to a successful transaction is having the financial capital necessary to accomplish the deal. Seller financing plays a role in more than 50 percent of mid-size business sales and nearly 90 percent of small-business transactions. Seller financing, often called owner financing, is an attractive option for buyers and sellers.
What is Seller Financing?
Owner financing occurs when the owner of a firm finances the purchase or a portion of the purchase of the business for the buyer. In other words, the seller becomes the lender. If the seller is financially stable, he or she can finance the entire acquisition for the buyer. More commonly, however, the owner finances the difference between the buyer’s approved loan amount and the selling price of the business.
As with other types of loans, the buyer repays the business owner by making payments from the cash flow derived from the acquired business. Seller financing for business acquisitions is typically a short-term loan, with the buyer repaying the owner within five years. Frequently, owner-financed notes include a balloon payment. With a more traditional lender also providing financing the seller note is usually subordinate or junior to the traditional lender. That means that if there aren’t funds available to repay both loans, the traditional lender is paid first and the seller note is junior to that bank note, and only paid when funds are available to do so.
Advantages for the Buyer
Seller financing for a business acquisition offers several benefits to the buyer. The key advantage to utilizing a seller note is that a traditional lender often considers this junior note as equity which means the buyer will have less money required to make the business acquisition. Additionally, if a buyer can’t qualify for a traditional loan, or if a buyer’s credit history limits the amount of a loan available, seller financing can be an ideal way to acquire a business while building up good credit. If time is a factor, seller financing can bridge the gap between closing the deal and the buyer securing other funding. Other advantages include lower closing costs, a flexible and potentially lower down payment and a faster closing process.
Advantages for the Seller
When a business owner offers seller financing, it opens the door to a wider range of possible buyers. This is especially beneficial if an industry is going through a downturn or is typically volatile. Seller financing nets the business owner a higher profit; not only does the seller receive the asking price for the company, but he or she also receives interest. Another benefit to the seller centers around the timing of the capital gains, which could delay the payment of taxes due on the gain on the sale of the business. Consult with your tax advisor for full details. Additional incentives for a business owner to finance the sale of a business include a faster closing turnaround, a higher interest rate compared to other investments and a potentially higher asking price for the firm.
In a tight credit market, owner financing can benefit both parties. It offers an option for a buyer who’s having difficulty securing conventional financing even though he or she is well qualified. When loans are hard to come by, selling a business becomes more challenging, so business owners are more open to considering alternative low-risk solutions.
When considering seller financing for a business acquisition, as with all financial transactions, both the buyer and seller need to perform their due diligence. At Links Financial, we always consider our clients’ best interests and have the knowledge and experience to guide them through the process. Contact us today to learn if seller financing is the right tool for you to acquire a new business or sell an existing business.