If you ask a seller if they will provide some financing to the buyer of their business, the first answer from most is “No, I want all cash.” This is out of concern for the risk of default. The seller worries that the buyer won’t pay back the loan. This is an understandable concern, particularly in today’s economy. But, the fact is that the vast majority of seller loans are paid back as due.
There are a number of ways that the risk to the seller is lowered. Sellers don’t provide financing to all buyers. Just like a bank, they look at the 3 C’s of credit – character, capacity, and capital. A seller will evaluate the buyer’s background and credit score, and rely on their own judgment of the buyer’s character. In addition, the seller will look at the buyer’s business experience to determine their likelihood of succeeding at the business they are buying. In judging capacity, the seller knows his business and the loan terms, and can decide if the business will generate enough money to pay back the loan. In evaluating capital, a seller can see what assets and net worth the buyer has to provide some collateral to support the loan. In addition, the business may have collateral to support the loan. The business itself is collateral and if the buyer defaults, the seller normally keeps the buyer’s down payment, gets the business back, and can sell it again.
Each party putting “skin in the game” is strong proof to trust the other. The buyer’s down payment shows the seller that the buyer is confident the buyer can be successful at the business. The seller giving financing for the balance of the purchase price provides evidence to the buyer that the seller’s business is good. Because its earnings will be needed to pay back the loan, the seller financing shows the buyer that the seller is confident of the business’ ability to do so.
Selling financing has additional benefits to both parties. The seller receives a much higher interest rate on the loan than they can obtain by putting the money in a savings account or CD. The buyer saves the fees and work involved in applying for a loan at a bank. Both parties get a deal done much faster. In today’s economy, a government guaranteed SBA loan is a common way that a small business sale is financed through a bank. But, SBA loans can take several months to get approved and funded.
There are many strong reasons for seller financing – to the buyer and seller – and that’s why many business sales are done with it.