What is Seller Financing?
In the simplest of terms, seller financing is when the owner who is selling the business provides the buyer a loan for the transaction. This is beneficial to a buyer who may not be able to secure a loan from the bank. Also, the closing process is faster and less costly in most cases. Instead, the purchaser usually makes a down payment to the seller and then makes incremental payments over time until the loan is paid in full. Much like a standard bank loan, a seller-financed loan also has an agreed upon loan term and interest rate.
Additional Benefits to the Buyer
In addition to allowing buyers to avoid strict qualifying requirements and to procure better rates and loan terms, seller financing gives the buyer time. Seller financing usually means less money down and an affordable monthly payment. This allows the new owner time to establish the business while maintaining some cash flow to pay bills and cover expenses. The loan term usually is much shorter in a seller-financed transaction, which means the buyer will need to pay a balloon payment (the outstanding amount due) at the end of the loan term. However, it’s usually easier to secure a bank loan to pay off the remaining balance, as it’s a much smaller amount than the original purchase price.
Downside for the Buyer
One downside for a buyer using seller financing is the fact it can be difficult to make a profit on top of what is owed in monthly repayment. The looming balloon payment at the end of the loan also can be a deterrent to some potential buyers, particularly those with poor credit that may not be able to qualify for a bank loan.
Benefits to the Seller
In a situation of seller financing, the seller is assuming the role of the lender. This means the seller decides on loan conditions, including the length of the loan and the interest rate. The seller also can move the property faster in most cases and there is a higher return on the investment. This is due to the fact that the seller is earning monthly interest, on top of the originally-agreed upon purchase price. Since the seller is not receiving the total sale amount up front, income taxes are much lower since the seller is paying taxes on payments received throughout the loan term, rather than a large lump sum.
Downside for the Seller
Offering financing to a buyer comes with added risks for the seller, mainly the risk of payment default. When a bank finances a business transaction, the seller obtains the money up front, so if the buyer stops making payments, the seller is unaffected. If the seller is putting up the money, a buyer’s failure to make payments means loss of capital for the seller. Further, because the seller is not getting a lump sum for the sale, up front, they have less capital to reinvest. They also maintain ties to the business until the loan is paid in full.
Pros Outweigh the Cons
In most cases, there are more pros than cons to seller financing for both the seller and the buyer. According to BizFilings, seller financing is used in up to 90 percent of small-business sales, and more than half the sales of mid-size businesses. Want to learn more about the upside and downside of seller financing, contact the Liberty Group of Nevada at firstname.lastname@example.org.