There are a few options when it comes to buying or selling a business. Seller financing, or owner financing, is one of these options. In short, the seller takes the role of the bank and gives a loan to the buyer, who will pay it back in repayments over a period of time. Seller financing is also an option for mortgages and deeds of trusts. This guide outlines the details of seller financing, and the advantages and disadvantages associated with it.
How it Works:
As stated above, seller financing works similarly to a bank loan. A legally binding business sale agreement is implemented between the buyer and the seller which sets out the terms of the deal. This includes a deposit amount (usually 10% of the purchase price), amount of instalments and the time period within which the loan must be paid back. Seller financing may either cover the majority of the financing or just a portion of it. During the repayment period, sellers have access to credit reports, financial statements and other information regarding the business and the buyer, much like the bank would. Additionally, the seller will set an interest rate which is often similar to bank rates or below.
Pros:
- Flexibility. Seller financing enables both the buyer and seller to negotiate the terms of the contract and rates much more than a bank would allow.
- Cost effective. Seller financing could be a lot cheaper than taking out loans from a bank. Interest rates could be lower too. The flexibility aspect also means that both parties could save time and money due to quicker closing times. As a buyer, you may have access to a higher loan amount than the bank would grant you. Sellers could make more money via seller financing because it is attractive to a large range of buyers, as they can make repayments over a period of months or even years.
- Fast transactions. The selling and purchasing of property can be done much faster using seller financing. This is because the arrangements are more personal and flexible.
Cons:
- The buyer could default. This is one of the main risks when it comes to financing, and it is a risk taken by banks when they hand out loans as well. If the buyer is no longer able to fulfil their obligations, the business is either repossessed or foreclosed. This could mean the seller has to find a new buyer, or restore the business.
- Sellers need to fork out the loan. As a seller, you need to be incredibly financially stable in order to take out seller financing. If you are relying on the repayment of the loan and the interest for other businesses or finances, then seller financing could pose a major financial risk if it falls through.
- Higher rates for buyers. Although seller financing can be quicker and more flexible, this could also mean more costs. Sellers can inflate their interest rates and purchase prices to account for the risks.
Conclusion:
Seller financing can be a much easier and cost effective way to buy or sell a business. However, it does come with a series of risks. To reduce the risk of a default, you should ensure that you only sell to a buyer who you know is reliable and financially equipped to buy and run your business. Clearly setting out the terms of the repayments, rates, and conditions in your loan agreement is also essential. You may also want to talk to a lawyer who specialises in buying and selling business to make sure you are making the best financial decisions.
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