Understanding Seller Financing
Does seller financing make sense when selling your business? Is there an upside to seller financing and does it does make sense? Selling a business comes with many challenges. The number one reason most transactions don’t close after a buyer and seller have “negotiated” a deal is that the landlord cannot come to terms with the seller and/or buyer.
The number two reason is that financing is not available.
For obvious reasons, a seller prefers cash. Based on analysis provided by Tom West of Business Brokerage Press, statistics show that sellers receive a significantly higher purchase price if they decide to accept terms. On average, a seller who sells for all cash receives 69.9 percent of the asking price. This adds up to a 15.8 percent difference on a business listed for $150,000, meaning that the seller who is willing to accept terms will receive approximately $24,000 more than the seller who is asking for all cash. The seller who asks for cash receives, on average, a purchase price of 36 percent of annual sales; compared to the seller accepting terms, who receives an average of 42 percent of annual sales.
To close this gap, seller financing can be the only solution, and it has more upsides for the seller than they first may consider.
The number one upside benefit is that tax is not paid on the money he receives from the buyer until it’s received. An accountant can break the tax position down in more detail but if the seller can delay paying taxes that’s a big plus.
The number two upside is that the seller can sell the note if there is an urgent need to obtain more cash. The note is bought for a discount on the face value of the note with the discount depending on different variables but includes the length of time before the note is paid in full, the creditworthiness of the buyer and the history of buyer payments on the note. If the note is being cashed two years after the note was started and the buyer has been making note payments on time, this will help the seller get more for the note as the buyer has shown a capacity to pay it.
In addition to the financial reasons covered above, there are other reasons for a seller to offer seller financing. These include:
- The chances of the business selling increase greatly.
- It will attract a higher offer from the buyer than a cash offer because the buyer can repay the note from the earnings of the business.
- It provides confidence to the buyer that the seller is prepared to “stand behind” the financial earnings of the business and the future success of the business including the buyer.
- Interest rates on money on deposit with the bank are at their lowest rate in many years. Reasonable interest rates on a seller-financed deal will add significantly to the actual selling price.
- With interest rates currently the lowest in years, sellers can get a much higher rate from a buyer than they can get from any financial institution.
- There are tax benefits to the seller when accepting terms rather than those of an all-cash sale.
With all the positives, one of the greatest concerns of the seller is whether or not the buyer will be successful. However, if the buyer puts down a substantial deposit, the seller sees the buyer has strong motivation to succeed and will commit to the ongoing success of the business.
It is often difficult if not impossible for a buyer and seller to negotiate seller finance on their own. This is not only because of the emotions in the deal from each party but also due to the many ways to structure seller finance sale.
Your business broker with their professional skills can be of help by recommending a variety of payment plans that, in many cases, can mean the difference between a successful transaction and one that is not.
Seller financing is a positive tool in a transaction as it creates a win/win scenario for both buyer and seller; and that’s what inevitably leads to the successful conclusion of any transaction.
Are you thinking about selling your business? Would you like to know the value of your business? If you would like more information please visit my website business valuation.
For more immediate help you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.