Seller financing

When you begin exploring buying or selling a business, you’ll inevitably come across the term “seller financing.” What exactly is seller financing? It’s simply a loan by the seller to the buyer to facilitate the purchase of the seller’s business.

How it works

In the typical transaction, seller financing functions very similarly to bank financing, except that instead of coming from a bank, the loan comes from the seller. Usually, the term of a seller financing loan is from 3 to 5 years, with an interest rate close to what banks are offering. The payment structure should be designed to correspond to the business’s cash flow, so that the new owner can pay operating costs, take some profit out of the business to live on, and pay down the acquisition debt.

How often is seller financing part of the transaction structure?

The substantial majority of business sales involve some degree of seller financing.

Even with an SBA loan, banks will usually still require that at least 10% of the purchase price be financed by the seller. Why? The lender wants a concrete demonstration by the seller that she believes in the business and, by putting her money on the line, has a vested interest in its post-closing success.

Seller financing can also be used when a larger loan wouldn’t make sense for a bank due to the debt coverage service ratio. In such a deal, seller financing or a larger down payment may be the only way to achieve the desired purchase price when the commercial lender isn’t willing to lend more.

Seller benefits

Sellers can benefit from seller financing because:

• It increases the likelihood of a sale by increasing the pool of purchasers that can afford the business

• On average, deals with some seller financing command higher purchase prices

Buyer benefits

Of course, seller financing can benefit buyers, too, as it may allow them to purchase a business that they could otherwise not afford.