Seller Financing: Why It Makes Sense
If you are thinking of selling your business, one of the important issues to think about is whether or not to provide seller financing. Seller financing is an essential component in the sale of most small to medium-sized businesses for several reasons. First, many potential buyers don’t have the necessary cash to bridge the gap between your asking price and the amount of money they can borrow from a bank. Second, even if they do, buyers are often hesitant to invest every dollar they have into a business that to them is a new and untried venture. Third, most buyers (and their lenders) feel the best way to ensure a smooth and successful transition from one owner to the next, is for the seller to have some “skin in the game” after the deal closes. That way you, as the seller, will have a financial incentive to help the new owner should he or she run into any hiccups during the transition period after the sale closes. On the flip side, if you insist on an “all-cash deal”, many buyers will interpret that as a sign that you are not confident that the buyer or the business will continue to be successful.
In fact, that is often the reason sellers insist on an all-cash deal and are reluctant to provide any type of seller financing. They are afraid the buyer will not be successful and they will never get paid the amount they financed. While that is certainly possible, you should also consider the significant benefits that providing seller financing can provide. Statistics show that sellers are much more likely to receive a full price offer if they provide seller financing. On average, a seller who demands an all-cash deal will only get offers of 70-80% of the asking price. Why is this? It’s because a demand for an all-cash deal signals to buyers that you don’t have confidence in them or the business, to that makes the investment feel risky. As a result, they discount the price to account for that risk. So, for example, if your business is listed at $500,000, not providing seller financing could end up costing you $100,000 to $150,000 in lost sale proceeds. That is a “guaranteed” loss. On the other hand, if you provide $100,000 in seller financing in the form of a seller note that is repaid over 2-years, you may receive some or all of that money over time. So if you consider the discounted selling price as a guaranteed loss, then any money received through seller financing is money you wouldn’t have had before.
Even with this compelling reason to provide seller financing, you might still be hesitant. If that’s the case, it’s important to note that seller financing has advantages in addition to simply increasing the proceeds you receive. These include:
- Providing seller financing greatly increases the chance that your business will sell.
- The interest you receive on a seller-note is in addition to the selling price. For example, a $100,000 seller note at eight percent paid over three years, provides you with an extra $12,000 in interest payments.
- With interest rates at their lowest level in years, you can get a much higher interest rate from a buyer than you can by putting the money in a CD or bank account.
- The taxes due on the principal amount of the note are deferred until you receive the principal payment. That means that it is taxed in future years when your tax bracket is likely to be lower than it is the year you sell your business. This can save you a lot of money in taxes.
- Financing the sale helps ensure the future success of your business, which your buyer and employees will greatly appreciate.
- Providing seller financing allows you to play a passive or inactive role in your business until the note is repaid.
Obviously, there are no guarantees that the buyer will be successful in operating the business. However, it is important to keep in mind that, in most transactions, buyers have a lot more at risk than you do. They have likely invested all of their liquid capital, provided a second lien on their home, and personally guaranteed the bank loan. As a result, they are highly invented to do whatever is necessary to ensure that the business succeeds. Although this investment doesn’t ensure the business will be a success, it means your buyer will work very hard to make it so.
The last thing to consider is that there are lots of different ways to structure any seller-financing you provide. Talk with Sport Club Advisors about the different solutions we have to that can minimize your risk and, in many cases, mean the difference between a successful transaction and one that fails.
Because of the benefits to the buyer, the buyer’s lender, the business, and the seller, approximately 80% of the deals closed last year included some type of seller financing. So, if you are serious about selling your business, consider the pros and cons of offering seller financing and talk with Sports Club Advisors about the best way to structure that financing to ensure your deal closes and you minimize your risk.