By Trent Lee, Business Broker for the First Choice Business Brokerage Franchise
If you’re thinking about selling your business, there’s a high likelihood that some portion of the total transaction will include seller financing. According to a 2019 Market Pulse survey from Pepperdine Graziadio Business School, closed deals with a sales price between $1 million and $2 million on average, were 17 percent seller financed.
As a business broker working with business owners who are ready to sell, I’ve handled the advertising and marketed seller financing terms. Given the chances that there will be seller financing involved if and when you sell your business, here are the seven points you should consider during the process.
1. Advertise seller financing terms on your business listing.
In the small business industry, the buyer pool is much larger for sellers who offer seller financing. Not only will you find your potential buyer more quickly, but you’ll also be able to request a higher selling price, rather than waiting for an all-cash buyer who will typically want a discount on the total purchase price.
2. Consider seller carryback terms.
The terms you agree to will be unique to your business, but I’ve found that terms typically range between two and seven years, depending on the amount being financed. Interest rates for seller financing are often somewhere between 6 and 10 percent; however, the interest rates have a lot to do with the specifics of the deal and the ability of the buyer and the business to service the loan payments.
3. Assess the buyer’s qualifications.
Do you trust that the buyer is someone who has the experience, competence and personality to continue to operate your business profitably? This and other questions are important for you to get comfortable with since you will have an interest in the ongoing success of the business.
Some sellers check the buyer’s personal credit report or ask for a resume to get a better idea of the buyer’s background, training and experience. This can give you some assurance that the buyer will be able to operate the business successfully and continue to pay you back.
4. Leave the DIY mentality at the door.
When buyers and sellers try to handle closing outside of escrow or an attorney who specializes in business acquisitions, I’ve personally witnessed that it doesn’t usually end well for either party. As a seller, be sure to have a professional draft the seller financing note.
You’ll want the buyer’s personal guarantee written in a promissory note as well as a security agreement. Legal counsel should handle this important aspect. A do-it-yourself mentality has no advantage at this vital stage in the transaction.
5. Ask for collateral.
In real estate, you hold the property itself as collateral; however, in a business transaction, there is often less collateral to hold on to as the seller. You can collateralize the assets of the business or be in the second position if there is bank financing involved, but you may also want to ask if the buyer has personal assets that they’re willing to pledge as collateral. At a minimum, have a security interest with a UCC-1 lien filed for your protection.
6. Consult a tax advisor regarding benefits.
By accepting part of the purchase price on terms and spreading out the payments over the term period, your taxable income from the transaction is spread out over that same period. Consult your tax advisor to understand how this affects you and your personal situation. It will likely lower your taxable income.
7. Require a sizable down payment from the buyer.
Seller financing is not without risk. One way to help mitigate this is to require a sizable down payment from the buyer. This helps minimize your exposure by ensuring the buyer faces greater risk. Unlike a home loan, where the buyer can put down as little as 3 to 5 percent, in a business transaction, you’ll want to collect a down payment of more than 50 percent so the buyer has more to lose than you do.
Unless you have a legitimate reason for financing less than 50 percent, I wouldn’t advise it. I have seen successful deals close with low down payments, but this is the exception to the rule. It might occur in the case of an employee/manager buyout, selling to a family member, or selling to a friendly competitor, but unless you have a specific reason and are selling to someone you’ve known for years, collect more than 50 percent down.
Trent Lee is consistantly the #1 ranked Business Broker in the nation for the First Choice Business Brokerage Franchise.