By Brian Slipka-CEO of Sunbelt Business Advisors of Minnesota
Click here to read the original article published by Forbes
An all-cash business sale may seem ideal, but it is quite rare. In the sale of both small and large businesses, it is common for the seller to finance a portion of the sale price.
For businesses with annual profits north of $2 million, there is an abundance of private equity and strategic buyer capital in the marketplace. Buyers of this type could easily cash out a seller, but they want leverage, so it is common for them to include seller financing in their offers.
For smaller companies, the Small Business Administration has popular loan programs for business acquisitions. In these deals, it is also quite common to see the seller finance a portion of the purchase price.
Why do so many business owners take less than 100% cash at closing for the business they poured their blood, sweat and tears into? Below, I’ll explore the reasons why sellers may want to offer financing to buyers, along with a couple of reasons why they might not.
The Pros Of Seller Financing
From the perspective of a business seller, here are some potential upsides of seller financing:
• In my experience, buyers typically view deals with seller financing as being less risky. Seller financing signals to the buyer that the seller believes in the business and its continued success. Moreover, when buyers perceive less risk along with growth opportunities, I’ve found that they tend to be willing to pay more for the business.
• Seller financing increases the pool of potential buyers and allows the seller and buyer to be more creative with deal terms than a bank would allow.
• In a seller-financed deal, the seller is like a bank, and like a bank, the seller will charge interest and can make significant returns on this interest. For example, with a 7%-8% interest rate with a 10-year amortization, a seller could realize a return in the ballpark of $30,000 to $40,000 for every $100,000 financed.
• The due diligence process is often more expedient because buyers feel assured by the seller having skin in the game.
• There are potential tax benefits. Seller financing typically involves spreading payments over five to 10 years. Taking a lump sum from a business sale would obviously increase the seller’s income in a year, which may result in them reaching a higher tax bracket. Spreading out payments may diminish this possibility; however, business sellers should consult a licensed tax advisor and a CPA on this potential benefit.
The Cons Of Seller Financing
There are some potential downsides to seller financing, as well:
• There’s a risk that the buyer could default on payment obligations. A buyer who turns out to lack managerial acumen or entrepreneurial skills could damage the business. This is why it is important for buyers to be vetted properly and for their loans to be secured. A business seller must think like a bank: Is the buyer a good fit? Does the buyer have transferable experience? Does the buyer have working capital to support the business?
• A seller-financed deal may attract a higher price, but it yields less immediate cash at closing. If the seller needs the cash for other investments or if the business has a lot of debt to pay off, then seller financing may not be a good option for the seller.
Careful Consideration Required
Using seller financing presents both opportunities and challenges. The potential pros are compelling: a widened pool of potential buyers, perceived lower risk leading to potentially higher sale prices, substantial interest income, a streamlined due diligence process and potential tax benefits.
However, one must approach seller financing with a prudent eye on the cons. Risk looms in the form of potential buyer default, necessitating thorough buyer vetting and robust loan security.
By carefully weighing the upsides and downsides, sellers can make informed choices and realize an attractive return for everything they poured into building a profitable business.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
About Sunbelt Business Advisors of Minnesota
The Sunbelt Business Advisors Minneapolis office is the largest office in the Sunbelt network with a staff of over 50 advisors, associates, analysts, and business development representatives. In 2021 the firm was recognized by the International Business Brokers Association as the #1 firm in the country and the first firm in history to sweep all three first-in class awards. Sunbelt provides services to business owners interested in selling their businesses, assistance with merger and acquisition activities, complimentary business value assessments, and advice to business owners seeking to maximize their life’s work when they exit. The firm provides business brokerage and mergers & acquisitions services for companies with revenues from $500,000 to $150 million. More information is available at www.sunbeltmidwest.com (<Under $5 million revenue) and www.tnma.com ($5 – $150 million in revenue).
