Pros and Cons of Seller Financing
Many purchases and sales of small businesses use Seller Financing as to tool to facilitate the deal. In a typical transaction, the Buyer pays with cash, financing, or a combination thereof. With Seller Financing, sometimes referred to as “Seller taking back paper”, the Seller allows the Buyer to make payments over time, which eliminates the need for the Buyer to seek financing from an outside lender, such as a bank. If the Seller is open to this option, it can be the best financial choice for all involved.
Cons for the Seller: Seller does not get all the money at once. There is always the risk that the Buyer does not succeed in operating the business, which can happen for reasons relating to competence, but also for unrelated reasons such as death, injury, etc. In order to provide financing, the Seller must own all the assets free and clear or have the ability to pay off any liens against the assets at closing.
Pros for the Seller: It significantly increases the pool of buyers. The Seller may be able to sell “as-is” instead of being required to make repairs that might be required by a lender. Seller Financing often has 8-12% annual interest, which compensates Seller for some of the risk.
Con for Buyer: The flip side of the nice return for the Seller, the interest may be high.
Pros for the Buyer: Even though the interest rate is high, Seller Financing is significantly less expensive than bank financing because there are no appraisals, bank fees or bank attorney fees, all of which are expenses of the Buyer. It can be the bridge to business ownership for those who do not have enough cash to buyer a business outright.
Seller Financing can enable a transaction to close faster, and with less expense to the Buyer. The willingness of Sellers to offer financing is usually a sign that the Seller is confident their business will generate enough income to pay back the loan.
Some tips: Work with an attorney. The Promissory Note should be personally guaranteed by the Buyer. Seller should run a credit check on Buyer (get permission first!). Buyer should make a significant deposit, so they “have skin in the game”. Both the Buyer and the Seller should talk to a CPA about tax benefits. Buyers with poor credit should use this time to improve their credit score so they can obtain bank financing at a lower rate and repay the Seller early.
By: Laura Mullin
Laura is a business attorney, entrepreneur and partner at the Ferr & Mullin P.C. in Rochester, New York. She has extensive experience working with buyers and sellers of small to medium sized business. To contact Laura, you can call (585) 869-0210, visit www.FerrMullinLaw.com or connect with her via email at LMullin@FerrMullinLaw.com.