Seller financing is a loan provided by the current owner of a business to the new owner of said business.
Buyers negotiate seller financing for a number of reasons. First, they may be unable to afford the business at the full asking price. Second, the business transaction, as is, will not qualify for a traditional loan. Finally, there may be a level of uncertainty that the business will continue to be successful without the previous owner at its helm. So an owner’s willingness to finance a portion of the sale often gives that business an edge over the competition, by removing some of the buyer’s uncertainty.
It is important for a seller financed transaction to be handled by professionals who can offer advice and construct documents that protect both the buyer’s and seller’s interests. Typically, a promissory note is drawn up that illustrates the details of the agreement. This note includes the recourse that the seller can take if a buyer defaults on the note. In the sale of a small business, the most likely scenario is that the seller would have the right to take their previously owned business back into their possession. Additional recourse avenues could be using the assets of the business as collateral or using a personal guarantee from the buyer. Utilizing a professional advisor to construct the terms of the promissory note will ensure that recourse actions are well structured.
The terms of the note are constructed in order to give the buyer adequate time to repay the note. Payments must be in an amount that the buyer can afford from the business income while continuing to run the business at an optimal level. The last thing either party wants is for the loan terms to constrict the buyer and eventually put them out of business. For this reason, the term length of seller financing varies depending on factors including: size of the loan, revenue of the business and the capital investment of the buyer. The interest rate charged on a seller financing note is typically in line with current banking rates.