Traditional financial methods may not always be appropriate or accessible for internet business purchases. In the right circumstances, seller financing can be a beneficial option for both the buyer and seller.
This article discusses seller finance as it applies to internet business buyers and sellers. You will learn about the potential benefits and cons of seller financing, as well as when it makes sense.
What is Seller Financing for a Business?
Seller financing enables the buyer to acquire a firm without relying on traditional financial sources. In this arrangement, the seller of the business effectively gives the buyer a loan, allowing them to buy the business without having to go to finance companies, banks, or institutional investors. By using a seller note, the buyer obtains the ability to reimburse the seller over a certain length of time with interest.
Typically, the seller obtains a share of the proceeds up front and agrees to fund a portion of the business acquisition. The buyer is liable for making periodic payments to the seller (typically monthly) in accordance with the stipulated terms.
For example, if the business’s selling price is $1 million, the buyer may pay $600,000 upfront in cash, with the remaining $400,000 covered by seller financing. The buyer would be liable for repaying the debt in monthly installments at an agreed-upon interest rate over a certain length of time.
When the buyer does not have enough funds or is unwilling to put up enough cash upfront, seller financing allows the acquisition to be completed. While SBA loans and other more traditional funding methods are sometimes available, certain purchases, businesses, or buyers are not eligible due to limits.
How Seller Financing Works
The procedure starts with a negotiation between the buyer and seller. Both sides must agree on the purchase price, the amount of seller financing (often a percentage of the overall price), the interest rate, and the payback schedule.
Here is a breakdown of the steps.
- Agree on Terms: Both parties negotiate and agree on loan terms, such as the amount, interest rate, and repayment plan. This is generally done with the assistance of legal and financial consultants to verify that the terms are fair and in accordance with applicable laws and regulations.
- Draft a Promissory Note: The seller gives the buyer a promissory note. This is a legally binding contract in which the buyer agrees to repay the loan on the agreed-upon terms.
- Secure the Loan: The loan is typically secured by business assets, which means that if the buyer fails on the loan, the seller has the right to seize the business assets.
- Complete the acquisition by selling the business and transferring it to the new owner. Typically, the buyer pays a portion of the sales price in cash at closing.
- Payments: The buyer pays monthly payments to the seller in accordance with the provisions of the promissory note. Payments usually contain both principle and interest.
- Lien Release: Once the loan is entirely returned, the seller releases any liens on the business, and the buyer takes full ownership of it.
The seller should evaluate the buyer’s creditworthiness and, in many circumstances, his or her expertise and ability in business management. This type of financing requires a high level of confidence and transparency between the buyer and seller. Sellers must exercise caution because if the buyer fails to complete the transaction, they may not get full repayment of the debt.
The Advantages of Seller Financing for the Business Owner
Most sellers like to get 100% of the monies in cash up advance. This is generally achievable with small acquisitions under $1 million, but agreements exceeding that amount are more likely to require financing. In a buyer’s market, many smaller transactions will also require seller financing.
Marvin Karlow, Senior M&A Advisor at Raincatcher, states, “The simple truth is that there are relatively few “all cash” transactions. Sellers who accept that some of the purchase price will be postponed are more likely to complete the transaction successfully. Sellers who are unable or unwilling to leave at the altar.”
Although most sellers prefer cash, providing seller financing has certain potential advantages.
1. Increases the Chances of the Business Selling (Larger Buyer Pool)
Seller financing increases the number of possible purchasers who can afford to buy the business. This is because it minimizes the amount of cash that a buyer requires up front, allowing more people with less cash on hand to make an offer.
Because seller financing offers more flexible financing terms than regular bank loans, it appeals to purchasers who may be unable to obtain a normal loan.
Offering seller finance broadens your pool of possible purchasers, boosting the likelihood of selling your business.
2. Creates Income from Interest Payments
One of the primary advantages of providing seller financing is the ability to earn more cash through interest payments. When you finance the sale of your firm, the buyer agrees to repay you in installments with interest. This means that, as time passes, the accrued interest will increase the amount you earn on the sale.
3. Potentially Reduced Tax Liability
Tax ramifications might be a major issue when selling a firm. With seller financing, you may be able to lower your tax obligation by spreading the profits from the sale over several years.
Instead of getting a lump sum payment and paying taxes on it all at once, you may be able to reduce your tax burden by collecting installments from the buyer over time.
It’s critical to consult with a CPA или tax specialist who can advise you depending on your individual circumstances.
4. Potentially Higher Selling Price
In some circumstances, providing seller financing might lead to a higher selling price. Buyers may be willing to pay extra for a firm that provides flexible payment choices and allows them to bypass traditional financing.
Furthermore, a wider buyer base and increasing demand might lead to a higher selling price.
5. Makes a Purchase Possible if Other Funding Isn’t Available
As previously stated, traditional financial sources may not always be available for online business acquisitions. In these circumstances, seller financing can help a buyer acquire a business that they would not have been able to otherwise.
6. Shows That the Seller is Confident in the Business’s Future
One significant benefit of seller financing is that it demonstrates the seller’s confidence in their firm. A seller’s readiness to fund the purchase indicates confidence in the company’s survival and future success.
Drawbacks of Seller Financing for the Business Owner
1. Greater Risk
Although offering seller finance has the potential to help the seller, it also carries hazards. By making a loan to the buyer, the seller acts as a lender. This means that if the buyer defaults on the loan, the seller may never receive the full amount due.
If the loan is secured by the business’s assets, the seller may be able to recoup their losses or reclaim possession of the company. However, it is feasible that the business will be in poor form at this point and have little value. In addition, the seller may have to go through a lengthy and expensive legal process in order to collect monies or assets.
2. Missed Opportunities from Not Having the Cash Upfront
While interest payments benefit the seller, the money used to finance the transaction cannot be utilized elsewhere. This means that the seller may pass on chances that would be accessible if the transaction was for 100% cash up front.
3. Interest Rate Risk
Another aspect influencing the possible benefits and cons of seller financing is the loan’s interest rate. If interest rates rise, the seller may receive a smaller return.
Risks of Seller Financing for the Buyer
1. Ongoing Payments Can Limit Capital for Other Expenses
When a buyer chooses seller financing, they must make continuous monthly payments to the seller, much like they would make mortgage payments to a bank. This reduces the availability of funds for other expenses and investments because these payments may consume a considerable part of income.
This can have an influence on the new owner’s capacity to grow the firm because they may lack the finances to invest in employees/freelancers or other resources that will help the business thrive.
2. May Prevent a Clean Transition
In some circumstances, seller financing can cause issues during the ownership transition. Sellers maintain a vested interest in the business because they receive recurring payments from the buyer. This might lead to opposing perspectives and decision-making, limiting the new owner’s capacity to completely take control and implement critical adjustments for growth.
How Can Sellers Protect Themselves from Buyers Not Paying?
While seller financing carries risks, there are various ways that sellers can use to lessen the likelihood of these possible disasters.
Require a Significant Down Payment
One of the most effective approaches to reduce risk is to obtain as much money as possible upfront. A high down payment displays the buyer’s commitment while reducing the seller’s possible losses.
Thoroughly Vet the Buyer
Due diligence must be completed prior to giving funding to a purchase. This process may include reviewing the buyer’s credit history, learning about their business experience, and evaluating their business strategy. It’s also critical to evaluate their financial situation and determine their ability to make payments.
Secure the Loan with Collateral
Securing the loan with collateral can give another layer of safety. The assets of an online business (including the website) may be used as collateral for its sale. This means that if the buyer fails to make payments, the seller might seize the assets.
Hire a Lawyer to Draft the Agreement
A well-drafted sales agreement can offer significant protection to the seller. Engaging a lawyer to prepare this document protects your interests.
When It Makes Sense to Offer Seller Financing
Under certain conditions, offering seller financing can be a sound business option. Here are some examples where it makes sense:
- When the market slows: During a slow market, acquiring customers can be difficult. Offering financing can attract more potential buyers who might not otherwise be able to purchase your firm outright.
- When looking to sell quickly: If you want a rapid sale, offering seller financing can broaden your pool of possible buyers, increasing your chances of finding a buyer faster.
- When you believe in the company’s future success: If you believe the company has a strong potential for growth and profitability, providing funding might be a strategic move to ensure a higher sale price while minimizing risk.
- When the buyer has a solid track record: If a buyer has a track record of success in the industry or appropriate experience, providing financing may be less risky because they are more likely to succeed following the acquisition.
- When typical financing sources are not available: Conventional financing may not be accessible for all internet business acquisitions.
When it Doesn’t Make Sense to Offer Seller Financing
In some cases, extending seller financing may not be in your best interests.
- When you need all of the cash immediately: If you need immediate cash from the sale of your firm, seller financing is not for you. Payments are made on a predetermined schedule, therefore the amount of money you receive initially will be reduced.
- When a buyer has bad credit: If a potential buyer has a low credit score or credit history, they may pose a high default risk.
- When the purchaser has limited commercial experience: If the buyer lacks commercial experience or knowledge of the industry, there may be concerns about their capacity to successfully manage and grow the business.
- When the business declines: If your business is in decline or has unknown future prospects, offering seller financing may be risky. If the business continues to collapse under new ownership, the buyer may fail to make payments.
Seller finance offers both advantages and disadvantages to sellers. Like any financial decision, it takes serious consideration, rigorous due diligence, and sound judgment. Every transaction is unique and influenced by a variety of circumstances, including as market conditions, the buyer’s experience and creditworthiness, and the seller’s financial needs.
Financing is typically a barrier to purchases, although seller financing may be an option. In some cases, sellers may be required to accept seller financing in order to complete the transaction.
If you’re thinking about seller financing, consult your attorney and accountant for specific guidance.