Frequently Asked Questions About Seller Financing ("Carrying Paper')
> Back to Key Questions
Q: What is “seller financing”?
A: An agreement by a business seller to receive part of the purchase price over time from the buyer, after the sale.
Q: What are typical seller financing terms?
A: 50% down payment at closing, 50% paid over 3-5 years, with 7-9% interest, secured against all the assets of the business only.
Q: I really want all cash at closing. How does seller financing benefit me?
A: For most businesses, all of the following is true
- You are more likely to sell the business if you offer seller financing than if you don’t. Businesses are hard to sell. The average business broker nationwide sells only 1 out of 5.5 businesses listed (VR sells 40%). Without seller financing, the odds are much worse.
- If you offer financing, you will get 20-25% more money—plus interest, according to statistics from VR and the International Business Brokers Association.
- The business will sell faster.
- You avoid wasting months of time demanding all cash. Most seller wants all cash. We understand that. But more than 75% of the sellers who actually sell their businesses nationwide finance part of the purchase. Most sellers who are serious about selling eventually agree to finance, usually after months of lost time seeking all cash.
- There are usually substantial tax advantages to deferring part of the payment. You should consult a tax advisor regarding your situation, but generally speaking, you only pay taxes on proceeds as they are received. Taking payments over time can help avoid a surge in income and huge tax bill in the year of the sale.
- You typically earn 7-9% interest on the pretax note principal. If you are paid all cash, you will have to pay taxes right away, leaving only the after tax proceeds to invest at what is likely to be a lower rate of return. So seller financing gives you a higher return on a larger pretax sum.
As an analogy, when you are investing money, you can put your money in bank CDs, and be guaranteed a return of a few percent per year. Or you can invest in stocks or mutual funds, which have generated returns of roughly 12% annually compounded over many decades, yet in any given period can decline in value. Over the long haul, stocks are a far better investment than CDs. Similarly, experience has shown that on average sellers who are willing to receive part of their proceeds over time with interest will come out far ahead of sellers wanting all cash. But on any particular deal, a bad outcome with seller financing is possible. The key to a good outcome is rigorous screening and qualifying of buyers.
Q: Are there businesses for which seller financing isn’t helpful?
A: There are some exceptional businesses for which seller financing doesn’t add much to the value, and that buyers and banks will fund 100%.
Q: Why is seller financing so important to getting deals done?
A:
- Banks are willing to finance few business acquisitions. For the few they are, some seller financing significantly adds to their willingness to lend.
- Very few buyers have enough money to pay 100% of the purchase price, without taking on an excessive amount of risk
- Financial advisors recommend putting no more than 25-30% of net worth into a business acquisition
- The few buyers with enough money to pay cash for 100% of the purchase price with less than 25% of their net worth, strongly prefer easier, passive investments such as commercial real estate.
- Buyers can purchase a business with twice the earnings power from a seller willing to finance 50% than from a seller who is not, since price is a multiple of earnings. There is no reason for a buyer to choose to cut their earnings in half to buy from a seller demanding all cash, particularly given the following consideration…
- Many buyers don’t trust sellers who don’t offer seller financing. There are a million ways a seller can take advantage of a buyer, including but not limited to failure to disclose material negative facts about the business, falsifying financial statements, making exaggerated claims of all kinds, failure to train the buyer as promised, competing directly with the buyer after the sale (or through friends and relatives), stealing customers and employees after the sale, etc. Sadly, these are not hypothetical threats or mainland problems. We have discovered over the years (in retrospect) that 10-15% of our own clients have materially misrepresented their businesses to us and/ or to buyers. Your refusal to finance the sale conveys to buyers that you are hiding something, lying, and/or unlikely to fulfill your obligations in the agreement, such as for training and non-compete. All the leading books, web sites, advisors, and other resources for buying a business urge buyers to insist on seller financing to protect against these risks.
- A large percentage of buyers we will not consider businesses for which seller financing is not offered.
Q: Will I have an opportunity to approve the buyer before committing to financing?
A: Absolutely! Any offer of seller financing is contingent upon your satisfaction with the buyer’s credit, statement of assets and liabilities, work history, management experiences, work and personal references, background check, etc. We encourage you to thoroughly check out buyers before closing a deal with seller financing. If you are not completely satisfied with all you discover, then you can reject the buyer.
Q: What kind of protection/ recourse do I have if the buyer doesn’t pay?
A:
- The buyer will need to sign a promissory note specifying the amount owed; the number, amounts and timing of monthly payments; the interest rate, penalties for late payments, etc.
- A security agreement is an extremely detailed document, typically about 10 pages, that provides security against the assets of the business to ensure full payment of the promissory note. Provisions of the security agreement include but are not limited to: exhaustive definition of all business assets secured; public notice (lien) against the assets of the business; protection against other encumbrances; restrictions on the sale, movement or other disposition of business assets; requirements on buyer to insure and otherwise protect those assets; provisions for seller to receive regular financial reports on the performance of the business; comprehensive definition of a default on the promissory note; etc.
- Our standard purchase and sale agreement calls for mediation and binding arbitration in the event of default, greatly reducing the likelihood of needing to go to court
Q: Can I demand the buyer to put up his house or other real estate as collateral?
A: Asking for real estate as collateral for seller financing is financially equivalent to demanding all cash, since real estate has been readily 100% finance-able. Moreover, getting a buyer put up his home as collateral is emotionally a tougher sell than trying to get all cash, because of buyer (and spouse) personal attachment to their home. The risk of losing one’s livelihood and home from a failed business acquisition is simply too great for 99% of buyers. Requests to buyers to put up real estate as collateral are destructive to the negotiation process; it is actually preferable to insist on all cash.
Q: How likely is it that buyer will “run the business into the ground” and/or default on the promissory note?
A: In our experience it is rare for the buyer not to pay, unless s/he feels the seller greatly misrepresented the business or is competing against the buyer. It’s useful to consider the buyer’s position. In a typical scenario, a buyer is putting up 1/4 to 1/3 of his net worth to buy your business, and moving here with his family from out of state. He will have outstanding credit, work experiences, and business references (or you will not extend credit to him). If he doesn’t pay the seller note, you will likely have a very strong legal case to take the business back, unless you misrepresented the business or didn’t otherwise didn’t perform as promised. While there are no guarantees, under these circumstances, the buyer will be extremely motivated to succeed. If the business doesn’t work, he will lose a significant portion of his net worth, face legal action from you, and likely have to move out of state, or get a job.
Q: What if the disaster scenario comes true and the buyer does default?
A:
The rigorous security agreement referenced above will be invaluable in assisting you to get the business back. Our standard purchase agreement calls for mandatory mediation/ arbitration of disputes to minimize legal fees.
Note that even if the buyer only pays half the term of the seller note, you make as much money as you do in an all cash sale. If you have to take the business back, you could price it for a quick sale, further increasing your net proceeds vs. a cash price. See accompanying chart.
Q: Wouldn’t it be easier for you to get sellers signed up if you promised an all cash sale?
A: Absolutely, and more than a few intermediaries do this. But we believe it’s imperative to be honest with our clients, and not to over promise to get an engagement. Industry statistics clearly demonstrate that 75%+ of businesses sold are seller financed; any intermediary who says otherwise is not being truthful. It is certainly possible to sell some businesses for all cash (or with cash plus bank financing), or sell any business for all cash if the price is right and the seller is patient.
