Even in the strongest economy, it’s hard for would-be business buyers to find financing for their purchases. That’s why so many transactions rely on seller-financing. And while it’s often easier to deal with a business owner seeking an exit than a tight-fisted bank, seller financing comes with its own challenges. Here’s what you need to know if you want a seller to finance at least part of a company sale.
Expect to pay a higher price and interest rate
Remember that for sellers, offering financing to a buyer both increases risk and lowers return (at least in the short term.) It means they won’t receive the full proceeds of a deal at closing, and also requires them to take on more post-sale risk. So if you need seller financing to be part of the deal, be ready to pay a premium. How high a premium? It depends on the particulars of the deal, such as the portion of the sale the seller is willing to finance. Interest on the cash might also be higher than you'd see at a bank.
Prepare to make a substantial down payment
Typically, sellers finance one-third to two-thirds of the sale price. So you’ll need to make a big down payment to help mitigate the seller’s risk and opportunity cost. Be sure to consider how much cash you have for a down payment when determining what you can pay for a business.
Get ready to show your creditworthiness
For the seller, financing is an investment where the return is guaranteed by the buyer’s creditworthiness, repayment ability, and collateral. The expectations may be different than those of a traditional bank, but you still need to prove your creditworthiness by ensuring your credit score is up to par when it comes time to buy.
You’ll also be asked to secure the loan and sign a personal guaranty. In addition to a first mortgage and security interests in the company’s assets, you may be asked to offer personal assets as collateral. If you can provide additional assets to secure the loan, you can reduce the seller’s risk, increase the likelihood of a financed deal, and, potentially, secure more favorable terms, such as a lower purchase price or easier repayment schedule.
Prove you can operate the business
In a seller-financed deal, the seller maintains a stake in the operation until you’ve paid back the loan. As a result, he needs to be confident in your abilities. One way to bolster your credentials is to demonstrate you have the skills and temperament necessary to succeed. If you don’t have previous industry experience, consider compensating the seller to stay on for some time to teach you the ropes.
And as you negotiate, remember that many sellers may not be able to offer financing. If a seller plans to launch another business, for example, seller financing may be off the table. You can increase your odds by working with a business broker to narrow your search to businesses that are willing to consider a seller-financed deal.