Seller financing (a/k/a owner financing) is when a seller offers the buyer a loan to pay for a portion of the purchase price for the business being sold. There are pros and cons to negotiating a deal that includes seller financing. This article provides many of the pros and cons of seller financing from both the buyer’s perspective and the seller’s perspective.

Buyer’s Perspective

Pros:

• It gives the buyer additional access to capital to cover any financing gaps.

• The Seller may offer more flexible loan terms than a bank would provide. Oftentimes, Seller financing is structured as a short-term loan (3-7 years) with payments amortized over a longer-term (10-20 years), and a balloon payment at the maturity date. In such a case:

  • The buyer’s total monthly payments could be reduced to an amount that is affordable for the buyer or gives the buyer more cushion to use cash flow to pay bills and cover expenses during the transition period of the business.

  • The balance due at the end of the loan term is more likely to obtain traditional loan approval to refinance.

  • Typically, the interest paid is similar to what would be paid under a bank loan.

• The documentation involved with Seller financing is usually simpler than the loan documents used for a bank loan.

• Seller retains a vested interest in the future success of the business. As such, the seller may be more willing to provide additional advice and guidance in the future (at no additional cost to the buyer). This may also be a con (see below).

Cons:

• Seller retains a vested interest in the future success of the business.  This can be a con if the seller becomes overly assertive and does not respect the new owner’s autonomy.

• If the Buyer defaults on payments to the seller, the seller may be quicker to accelerate the loan and seek to take back the business than a traditional lender because while a bank would not have the expertise to operate the business, the seller would.

• Additional closing documentation will be required.  While not a huge undertaking, the seller financing will likely require the following documents: a promissory note, personal guaranty, security agreement, subordination agreement, UCC-1 filing, and potentially other security documents (e.g. Deed of Trust if real estate is secured).

• The seller will likely require that the individual owners of the buyer entity personally guaranty the loan.

• Increased seller due diligence may be intrusive to the buyer.  Typically, the buyer does most of the due diligence and the seller just wants to make sure the deal closes and the purchase price is paid. However, if the full purchase price is not being paid at closing, then the seller may want to do some additional due diligence on the financial wherewithal of the buyer and the ability of the buyer to operate the business successfully in the future.

• The buyer will likely have less negotiating power regarding the purchase price if the buyer requires seller financing to close the deal. The seller may even demand a higher purchase price if the seller is not going to receive the full purchase price at closing.

• Seller may require the individual owner of the buyer entity to obtain life insurance with the seller as the beneficiary to provide a source of repayment in the event the buyer passes away before the seller financing is paid off.

Seller’s Perspective

Pros:

• The seller earns interest on the loan.

• The seller typically saves on income taxes if it can treat the loan on an installment basis such that it only pays tax on the sale as payments are received over time.

• The pool of potential buyers increases if the seller agrees to provide financing.

• Typically, the sale can close quicker when the seller provides financing.

• The seller maintains some stake in the business during a transitional period to help ensure the enterprise continues to succeed and serve customers.

• The seller has more negotiating leverage to demand the full asking price.

• The seller may prefer to receive the steady cash flow over the course of the loan.

Cons:

• There is more risk involved. The seller takes the risk that the buyer fails to pay the amount owed.

• Seller maintains a vested interest in a business. This is a con if the seller would have preferred a clean break from the company.

• The seller has less immediate capital to reinvest. A seller that needs significant capital to invest in a new venture may not want to provide owner financing.

• The seller must do additional due diligence on the buyer to make sure that they are able to run the business in the future and make payments.  This would involve checking things such as the buyer’s credit score and available collateral.

• There is increased paperwork involved for the loan documentation (e.g. promissory note, security agreement, personal guaranty, UCC-1 filing).

• If the buyer also has a bank loan to facilitate the purchase, the lender will require contractual priority over the seller loan through a subordination agreement and potentially a standstill agreement.

• In case of default, the seller’s only option for collection may be to take back the business, which may be in a lot worse shape than it was when it was sold.