Experience has proven that seller financing, if properly managed, can result in a win-win situation for all parties involved. How is this possible?
Consider these points:
- Requiring cash most certainly reduces the number of prospects.
- Buyers may assume seller is not sufficiently confident in the business if there is no willingness to offer some level of financing.
- The asking price of a business is almost always greater than the value of its hard assets (FF&E and Inventory). The difference between the price and asset value is considered the “goodwill” or “intangible value” of the business.” Lending institutions may loan for the assets but will not finance goodwill. This is left to the seller of the business.
- One of the benefits of seller financing is that a higher price can be obtained for the business. Buyers will always discount the price by as much as 10-40% for “cash” deals.
- The seller will also receive more income as a result of the interest paid over the life of the loan. It is important to consult an accountant regarding capital gains consequences as well as the tax savings of an installment sale as compared to paying the entire tax in the year of the sale. Changes in tax laws in recent years make the use of a CPA or tax attorney highly recommended for these matters. Also consider the low rate of return if the proceeds of an all-cash sale are placed in an interest-bearing bank account.
- Naturally owners are reluctant to take back a note because of the risk of not receiving all the payments due. However, the steps below can be taken to minimize the risk:
- Request a credit report and check references to determine if the buyer is creditworthy and capable of managing the business.
- Require a sufficiently high down payment in the range of 25%-30%. Keep in mind that there will be more buyers available at this level than at an “all-cash” level. Consider that this amount may represent nearly 100% of the buyer’s available cash. Thus they will have a vested interest in managing the business in order to protect their investment.
- Require a payment schedule over a period of 5 years, perhaps 7 years, under certain circumstances.
- Require the buyer to personally sign for the loan.
- Require monthly and/or quarterly financial statements to allow the seller to regularly monitor the financial health of the business.
- File a UCC Security Agreement