Seller Financing – What is it, Why offer it, and How much to offer?
Let me start by saying that I’m big fan of offering seller financing. As you read through this article you’ll quickly pickup on that. Since I’ve stated my bias up front, I ask that you carefully read through the entire article to understand how to minimize your risk and maximize your profit when offering seller financing. At 1-800-Biz-Broker we are here to answer your questions. Call today to take advantage of our free and confidential business consultation/valuation.
What Is Seller Financing?
The owner/seller of the business offers to a loan to the buyer a portion of the sale price. The seller will decide the terms of the loan, which includes amount, length of time to repay, and the interest rate. Let’s say Joe wants to sell his machine shop for $100K. He may offer to provide seller financing for $30K at a rate of 10% interest for a term of 3 years. If the buyer agrees, Joe becomes the “lender” of the $30K, and earns the 10% interest on the loan amount. A promissory note is typically drafted to ensure all parties agree to the terms.
Why Offer Seller Financing?
Most importantly, seller financing increases the number of potential buyers of your business. More buyers typically results in a faster sale and potentially a higher sale price. As a return on investment, the seller earns interest on this loan at a much higher rate than most stocks, bonds, CDs or high interest savings accounts. Let me explain further by offering some pros and cons. Not all pros and cons apply to each situation (of course).
- Buyers are searching for businesses using the key words “Seller financing”
- Improves buyer confidence that the seller believes in the continued success of the success of the business
- Sellers can ask for higher price since approval of seller financing does not involve a third party
- Seller can spread the taxable income over a longer period
- Creates an additional financing option for loan challenged buyers
- Less time for loan approval than traditional commercial financing
- (again) Higher ROI than many investment options
- Typically backed by collateral if the buyer defaults
Before I get to the cons, let me go off on brief tangent – It’s no secret that baby boomers are retiring and offering their successful businesses for sale. This has contributed to an increase of 30% in sales of small-to-medium sized businesses. People recognize the opportunity, and in many cases are willing to risk a steady paycheck for a chance to own their own business and control their destiny. The profile of these buyers suggests they are risk averse, but willing to take a leap into small business ownership for “the right opportunity”.
- Promissory note is required
- Continues to tie the seller to the business until the loan is paid
- Many buyers expect the seller to remain involved in the business in some form
- Seller capital is tied and not available for other investments
- Legal consultation is highly recommended
- Buyer needs to be confident in the buyers ability to continue the success of the business
How Much Seller Financing To Offer?
For the sake of establishing baseline numbers, I would suggest limiting seller financing to no more than 20% – 30% of the asking price at a rate of 6%-10% simple interest for a term of no more than 5 years. With that said, there are many factors in determining the final terms. For example, if you are comfortable with the cons I listed above and feel the reward outweighs the risk, you should consider increasing the loan amount, length of term, or both. On the reverse, consider lowering the amount or term length to reduce your exposure to the cons. Regardless of the amount you are willing to offer, as long as you offer it, your listing will benefit from the increase in search results and improve buyer confidence.
If you choose to offer seller financing, you should always:
- Ask for a sizeable down payment
- Have confidence in the buyer to continue the success of the business
- Work with a financial advisor or business broker
- Secure collateral
- Work with an attorney to ensure your contract is airtight
- Be prepared to stay involved in the business to some degree
Are you considering to buy or sell a business? We are Business Brokers and have been helping entrepreneurs sell their businesses since 2006. Contact us today. Call 1-800-Biz-Broker
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