It has traditionally been a common practice for the sale of a privately-held small business to include some seller financing as part of the deal structure as a key to gettinga deal done.In the U.S., about 60% to 90% of business sales involve seller financing when bank financing is not an option.
Seller financing can accomplish several goals beneficial to both parties. Sellers can increase their pool of potential buyers. And, buyers feel there is reduced risk that the success of the business is tied to the involvement of the owners. By having the seller finance a part of the purchase price, it can give the buyer confidence in the fact that the seller believes the business can thrive without them. From the seller’s perspective, seller financing can help a buyer pay more for the business than if the deal were financed only through traditional financing sources.
With that in mind, it is important to remember that the purchase/sale of a business is a two-way street. Just as a buyer will conduct due diligence to determine the viability of the business, become comfortable with its financial and legal matters, and assess the opportunities for growth, a seller should be comfortable with the buyer as well, particularly if the offer includes a seller loan. The seller should understand the buyer’s business background and qualifications, motivation for buying the business, and financial capacity to purchase and sustain the business. Expect that the seller will pull the buyer’s credit history.
Business owners who extend financing to a buyer for the purchase of their business often ask, “What happens if the purchaser defaults on the loan?” Should that happen, the seller would be able to exercise whatever rights are defined in the security agreement that is associated with the promissory note. The seller would usually have the right to get the business back, which may not always be the best scenario if the business has declinedunder the buyer’s management andis not performing well. A seller should try to negotiate a personal guarantee by the buyer as part of the terms of the promissory note. The seller can also require the new owner to provide periodic financial reports on the performance of the business as part of the terms of the promissory note.
It is important for a seller to protect themselves should a default occur and will want to include certain conditions to protect themselves. There’s more to the sales agreement than purchase price. If the buyer defaults, the seller might want to retain the power to take back the business within 60 days of missing payment.The seller might also want the buyer to agree to keep the inventory at a certain level, in case they need to take over the business again.
It’s typical for sellers to stick around after the sale to advise/train the buyer about the business. Generally, they might stay anywhere between 30 to 90 days after the sale, based on the complexity of the business.And, a buyer might want to ask the owner to stay on as a consultant for as long as possible. For example, you might want them to be a consultant for six months or more. You’ll need to draft a consultant contract in this situation.
General terms of a seller note are typically in the range of 30% to 60% down payment, with interest rate between 6% to 10% with the loan term between 5 to 7 years.The loan should be sufficiently long to make sure monthly payments are manageable.
In the course of the seller’s due diligence on the buyer, it is acceptable to ask for their credit record, particularly if the buyer is an individual. Personal credit records are available through several outside services, as long as written authorization is given by the individual being checked out. There are standardized forms that can be used whereby the buyer grants permission for the seller to obtain credit reports from specific consumer reporting agencies. Many of these credit companies can be queried via the Internet, such as Equifax, Experian, and TransUnion. Another service that doesn’t require authorization is AAA Credit Screening Services. If a fee is charged to obtain the reports, the buyer can be asked to cover it. The seller may also ask the buyer for a list of financial and business references.
Seller financing can accomplish the goals of, and be beneficial to, both parties as long as each feels confidence in the other.
