Seller Financing Will Help You Buy A Business
Table Of Contents
Introduction
Most small businesses are sold using some amount of seller financing. What is seller financing? Seller financing, also known as owner financing, is a method of selling an asset, where the seller receives a down payment, and accepts the remainder of the sales price in installments directly from the buyer.
It’s accepted terminology to say that the seller is providing a loan. In reality the seller does not loan money to the buyer. The seller simply takes payments from the buyer for part of the purchase price. Calling it a loan makes it easier to write and talk about.
This article will give you ideas to help you buy a business using seller financing, and to understand a number of related issues.
Basic Ideas
Since the purchase of most small businesses involves some amount of seller financing, as a potential business buyer it will be advantageous to learn about seller financing ahead of time.
A business buyer may learn about seller financing from the business seller, but being prepared ahead of time will give you a big advantage.
Many small business sellers know little about seller financing, and many would rather not provide it.
It’s understandable that a business seller would rather be paid cash at closing, and could be advantageous.
Paying cash at closing means that the buyer has other sources of money to pay in full at closing. So no seller financing will be needed, but may still be desirable.
Being paid in full at closing can be problematic from a tax standpoint.
Seller financing has advantages for the seller discussed throughout this website and is often used to sell other assets such as properties and land.
Start With A Relationship
As you look ahead to buying a business consider that four entities are involved. There is the current owner, the current business, you as the buyer and the business after you own it. I believe that it’s necessary for you to form a winning relationship involving all four parts.
Before you can present an offer to purchase there is an essential “getting to know you” period. This may seem obvious but it is more than a quick meet and greet. You will need to build trust with the business owner to make an excellent deal that leads to long term success.
Considering the four elements of the relationship above, what are the strengths and weaknesses of the current business? What might the current owner be comfortable with, that you see as risks?
What additional challenges will you face as the new owner? For starters there will be the payments from the business purchase. What happens if you lose a large customer or face an expensive equipment purchase? Such issues could be easier to handle for the current owner if the business has been profitable.
As you consider these issues as a prospective owner, how will they shape your mindset? That said, you need to convince the owner that you are the right person to run the business moving forward. So be prepared to start a favorable relationship.
A favorable relationship will help you:
Learn details about the business that you wouldn’t learn otherwise.
Build the trust necessary for the owner to agree to seller financing along with other beneficial terms and conditions of the purchase agreement.
Maximize the willingness of the owner to stay involved in the transition to you taking over as owner. This could also make the owner more likely to help if you need advice in the future.
What Makes Many Businesses Unsellable?
Of course not all businesses are doing well all the time. This could allow you to find motivated sellers, even if their business isn’t currently for sale.
A widely held view is that only 20% of small businesses for sale will actually sell.
Many businesses will never sell because they will fail first. The difficulty of successfully operating a business is common knowledge. According to Tony Robbins 96% of businesses will fail over a ten year period. He provides 14 reasons why businesses fail:
- Not having an effective business plan
- Not putting the customer first
- Not hiring the right people
- Doing it all yourself
- Lack of flexibility
- Lack of innovation
- Not understanding your industry
- Fear of business failure
- The wrong mindset
- Lack of vision
- Lack of passion
- Ineffective marketing strategies
- Not understanding your X factor
- Asking the wrong questions
Based on these reasons there is a progression during the first 10 years of operating a business where many will fail. So many businesses will go out of business before they are for sale.
If you have an interest in owning a business, find opportunities to get involved during the 10 year period described above.
What skills and experience do you have that will help you improve on the existing shortcomings of a business? How can you operate this business profitably?
If you as a buyer have a good understanding of seller financing this will enable you to maximize such opportunities.
To whatever degree a business is succeeding, often there has been very limited preparation for the owner to actually sell the business. So that’s another reason that can make a business unsellable. Operating the business has not prepared the owner to sell the business.
A business is unsellable if the sales price is too high. This issue happens for a couple main reasons. First the owner attempts to sell the business on their own. Owners often have an unrealistic view of the value of their business compared to a proper valuation.
The second reason the price of a business is set too high is based on the advice others give to the owner. Proper business valuation can be challenging and often beyond the qualifications of the advisors involved.
A related example is the broker hired to sell a business, first needs to get hired. So they will use the sales price that the owner provides rather than explaining that it’s too high. Or the broker will provide the valuation of the business at a high price to look more favorable so that they get the listing.
To put the significance and complexities of business valuation in perspective, “Valuing A Business” by Shannon P Pratt is over 1100 pages. It is considered the leading book on the topic by the American Society of Appraisers (ASA).
For your reference here is a PDF copy of the 5th edition of Valuing A Business - The Analysis and Appraisal of Closely Held Companies.
As an alternative here is my article Valuing Your Business For Sale And To Sell Your Business Note. You will find business valuation concepts to help prepare in advance for the sale of a business, and if seller financing is provided, for the potential sale of the note.
One of the advantages of seller financing is the flexibility to create whatever terms work for both the buyer and the seller.
The concept that I am suggesting is similar to the approach by real estate investors looking for motivated sellers. Motivated sellers may have an issue or an opportunity that leads them to want to sell quickly.
However, something about the property the seller is motivated to offer, is less than ideal for the typical buyer, or even to be listed by a broker. For the right investor this will be an excellent opportunity.
Likewise, for some prospective business owners “unsellable” businesses will be excellent opportunities to acquire a business.
Other excellent opportunities to buy a business will occur before the owner has reached the “motivated seller” stage. So look for the right set of circumstances to buy a business, before the business is listed for sale.
Following up on the data that shows 96% of businesses will go out of business by year ten, what possibilities to purchase exist year by year? When would an owner who is not planning to sell their business, consider selling?
A common theme I suggest is better and better preparation. The better prepared you are to run a business, the better prepared you are to offer a solution to a business owner that might be getting frustrated. You could look at the list above of 14 reasons why businesses fail, and find ways that you are better equipped to handle that aspect of the business.
Make Seller Financing Work For You
Seller financing is an excellent tool that you can present to prospective business sellers. For you as the buyer being equipped with a good understanding of seller financing will give you a big advantage over other buyers.
This is so whether or not you are using a broker to find a business for you to buy. But knowing that many businesses are unsellable suggests that minimizing the cost of doing business is essential. So if you succeed in finding a business to buy on your own, that should be more cost effective.
Either way you will need professional representation. So find the best attorney and accountant that you can afford. Once again it will be an advantage for you to better understand seller financing beforehand.
Seller financing can be an advantage for business sellers. Some of these advantages are based on making it easier for the seller to find a buyer. Some of these advantages might sound not as attractive to buyers unfamiliar with seller financing. However, because of the challenges involved in buying a small business, some amount of seller financing is best for both buyer and seller.
Here are some advantages of seller financing for sellers:
As I’ve already stated, the biggest advantage for a seller to offer seller financing is finding a buyer that they would not have otherwise.
By offering terms instead of requiring all cash, a seller should receive a higher price for selling a business or a property. Either way the price has to be justified by an accurate valuation.
Seller financing is considered an installment sale by the IRS if structured properly. This provides tax benefits to the seller. Consider What Are The Tax Implications Of Seller Financing?
Seller financing can be combined with other financial resources to fund the purchase of the business.
By offering seller financing the seller can establish greater control over the marketing and sales process.
Closing costs are lower than with bank financing so the seller will not need to contribute to the buyer’s closing costs.
Seller financing will expedite the closing compared to bank financing.
The secured promissory note created to document seller financing is an asset that can be sold in a variety of ways.
Insights To Help You Create A Business Note
The last advantage of seller financing for sellers listed above can tie this process together. The documentation used to purchase a business this way will create a secured promissory note. In this case that note is often called a business note.
What is a business note? A business note is a group of documents used to formalize the sale of a business, when the seller receives some of the purchase price in installments.
For more information about such documentation take a look at my article What Is A Business Note.
As I said above, business notes are an asset that can be sold. The entire balance of the note can be sold, or a partial sale can be structured to meet the needs of the note seller. A partial sale will sell some of the remaining payments or a percentage of each payment that is sold.
If you purchase a business with seller financing, and the note is sold, the terms of the note remain the same. The only thing that changes for you is who you make your payments to.
The ability to sell a note or part of the note can be a significant benefit for the note holder, in this case the seller of the business. While notes are purchased at a discount, selling a note can be a timely source of cash.
As a potential buyer of a business, it will be helpful to understand the viewpoint of experienced note buyers. They have considered many seller financed transactions along the way. This resource will also help you create a favorable note to purchase the business.
Keep in mind that a note that is structured in a way that makes it most sellable, may not be ideal for you as the buyer of the business. Likewise, the structure of the note that meets the seller’s needs may not work for you. With those caveats in mind, here are some insights to create a seller financed business note:
Make sure that you as the payor on the note can afford to make the payments on the note. The other terms of the note can be adjusted to make the payments affordable, as long as you agree to a deal that provides sufficient cash flow.
Equal monthly payments are common but other options are available. One of the advantages of seller financing is the flexibility to create whatever terms work for both the buyer and the seller.
An alternative payment schedule could include no payments for the first six months of the note. Or if the business is seasonal, perhaps no payments or reduced payments during certain months of the year.
Stepped payments provide another alternative. Stepped payments, also known as graduated payments, increase gradually over time as referenced in the promissory note. The increases can be based on a fixed amount or a percentage increase. For example the payments increase by $100.00 monthly starting in year two. You will find more on this topic in my article What’s Better, A Balloon Note Or Stepped Payments?
The cash down payment should be 20% or more from the buyers own funds. Larger down payments are another way to reduce the periodic payments, all other terms being the same. Larger down payments can also make the note more desirable to note buyers.
The note interest rate should be set at least 3% above the prime rate. If the note is sold, note buyers can pay a higher price for higher interest rates. They do not like interest only notes.
Business notes often are short term notes, completing all payments within five to seven years. While this is desirable for business note buyers, the business buyer may need a longer term and that may work for the seller as well. And partial sales (part of the payments) of business notes are common. So that is an alternative for longer term notes.
The need for a longer term note by the buyer, may not be desirable to the business seller. This could be solved by adding a balloon payment to a longer amortized note. The balloon payment is one large payment made at the end of the note which completes all payments. While balloon payments are not desirable to note buyers, they may work for the business seller and buyer. Once again I refer you to What’s Better, A Balloon Note Or Stepped Payments?
From the perspective of note buyers, first liens are preferred and second liens often will not be considered. But a second lien might be purchased if the combined loan to value ratio is acceptable, and the cash flow is sufficient. The seller of the business might also plan ahead to keep the second position note and collect all the payments.
The promissory note must be personally guaranteed, or if only a corporate guarantee, the financial strength must be excellent.
Related to the item above, higher credit scores and an on time payment history on the note will be important points to note buyers. These should also be important points to the seller of the business. So the business buyer should be prepared for due diligence to validate past and anticipated credit history.
Conclusion
In order to buy a business, assuming that you are properly qualified, you still need the right circumstances and adequate financing. Exploring off market businesses can lead to the opportune time to buy a business. Will you be properly prepared to take advantage?
Developing a good understanding of seller financing will put you in a better position to close the deal. Below you will find more resources to help you prepare. Some of this information is written more from the perspective of business sellers and the possibility of selling the business note in the future. But this requires a business buyer to buy the business. How about you?
More Resources For You
Seller Finance Your Business In 2025
Do You Plan To Sell Your Business To Buy Another Business?
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