A Practical Guide to Seller Financing

A Practical Guide to Seller Financing

A Practical Guide to Seller Financing

Selling a business is one thing, getting paid on the sale is another.  The options available for financing the deal are dependent on the business and the buyer. Here are some things to be aware of if you find yourself with a chance to sell your business.

Seller Financing:  The good, the bad and the uh oh

Seller Financing as the ONLY Financing

The Good:

  1. Seller provided financing opens the sale up to a wider range of buyers (though not necessarily higher quality buyers).
  2. Without a 3rd party lender (SBA, Bank, etc) the deal can likely get to closing faster than if bank financed
  3. Buyer usually isn’t as price sensitive since there usually isn’t a 3rd party valuation
  4. You may be able to cross-collateralize or obtain cross default agreements to tie up assets.
  5. If you get a personal guaranty from buyer you may have better chance to get paid.

The Bad:

  1. If the buyer defaults on the note it can be expensive to try to collect
  2. If you worry as much about the note payment as you did about the business are you any better off?
  3. Unless done properly there can be all kinds of tax issues

The Uh, Oh:

  1. If the buyer has a lease on facility you may need a landlord subordination agreement or you won’t be able to get to the collateral or worse, you might have to pay the back rent in order to get to your collateral.


  1. Get the landlord subordination agreement at the time of the sale.
  2. If you can, cross default the lease and note so that if buyer is in default on either they are in default on both.
  3. Make certain to file a UCC1 on the collateral assets so the whole world knows your note needs to be paid before the assets can be sold.
  4. Try to get a really high default interest rate on the note so that the financial pain of default is high.
  5. Consider a sub-lease to the buyer rather than buyer getting a new lease. That way you retain control of the facility and can act faster if you need to intervene.
  6. Try to get collateral other than business assets. Does buyer have a vacation home? Other assets?
  7. Guarantors – get as many guarantors as possible also make sure spouse signs guaranty if required in your state.
  8. Require buyer to provide financial statements and tax returns to you for as long as the buyer owes you money so you can keep an eye on the business health.

Seller Financing with Other Types of Financing

SBA Loans with subordinated Seller note:

The Good:

  1. The Bank is likely to screen the buyer more thoroughly than most sellers
  2. The seller note is likely to be less than 10% of the total selling price.

The Bad:

  1. The bank will look very carefully at the business cash flow (several years), seller financials need to be in good order.
  2. Bank will require a 3rd party valuation to make sure the price the buyer and seller agreed to is fair.
  3. SBA limits any “after the sale” arrangements between buyer and seller.
  4. The seller note will likely have a period (usually 2 years) whereby the seller gets NO payments and only interest accrues.
  5. If buyer defaults on seller note the Bank will limit what actions the seller can take to get paid.

The Uh, Oh:

  1. Because of the restrictions in the bank subordination agreement the seller note is usually the first obligation that goes unpaid.
  2. If the seller stops paying you it’s usually a sign of other significant problems with the business.
  3. If the buyer stops paying the note the seller recourse is basically limited to enforcing the personal guaranty.

Revolvers (also known as Asset Based Loans) – with associated seller note

Definitions: a “revolver” is a bank loan or financing company loan that gets adjusted every month (or week or even day). These revolvers are tied to accounts receivable (a/r) and/or inventory and are a % of those items. For example a common revolver term is a bank loans the business up to 70% of current accounts receivables and/or 20% of good inventory at cost.  (The a/r % is high because a/r is highly liquid and can be collected quickly. Inventory is much more difficult to liquidate and has high costs associated with liquidation i.e., warehousing, transportation, auction costs etc.)

The Good:

  1. A revolver is flexible in that if funds cashflow when the business is growing.
  2. A revolver usually has fewer covenants.
  3. The “credit worthiness” of the business is less stringent than normal bank standards

The Bad:

  1. The seller note will lose a/r and inventory as collateral.
  2. The revolver lender usually can “pull the plug” at any moment
  3. The cost to the borrower can be significantly more expensive than an SBA term loan.

The Uh, oh:

  1. Revolver loans normally have many fees and opportunities for lender to squeeze a few more dollars out of borrower
  2. Revolvers are famous for high cancellation fees if you want out of the deal.

Credit Card Loans Against Receipts – along with seller financing

Description – With these loans a lender “forecasts” your credit card receipts and lends you money in advance, then when the customer credit cards are process for the business sales then the money is redirected to lender to pay off the loan they advanced. Generally speaking these loans are used for retail stores, restaurants, etc with high % of credit cards sales and highly predictable and regular sales. Take the time to calculate the real costs of this kind of financincing, it can get expensive quickly.

The Good:

  1. If you have high volume of regular credit card sales these loans are not difficult to obtain
  2. The cashflow is steady

The Bad:

  1. These loans can be very expensive
  2. The CC lender gets paid before the seller note by taking their money out of the sales revenue.

The Uh, oh:

  1. Because these loans have a claim on all revenue it is very unlikely any other 3rd parties would provide financing.
  2. The process of payment takes control of cashflow out of biz owners hands (which could be a good thing in some cases)

If you are selling a business you’ll need to risk adjust the price depending on the financing structure that the buyer and seller agree to. Also, make sure to get good legal and accounting advice to understand what the net value is. And finally, look closely at the risks associated with any financing arrangements.

Business Partnerships – The good, the bad and the ugly…

In my line of work we run into business partnerships every day and we are often the ones trying to figure out how to resolve the myriad issues, problems and crisis that revolve around the small business partnership dynamics. A wise person once said famously,

Choose your business partner twice as carefully as you choose a spouse..because your spouse can only take half of what you have.”


Business partnerships can be a wonderful thing, especially in the early stages in the life of a small business start-up. The sense of mission and teamwork can be addictive. But what we often see is that the business partners didn’t really agree to anything before they become partners.


Often the partnership conversation goes like this:


Mary, “Bill, I have a great idea. I’m going to make ice skates that have training wheels.”


Bill, “Cool, I have some free time, I can help. Want to be partners?”


Mary, “Sure 50/50”


Bill, “Awesome, let’s go to Starbucks and noodle out a plan.”


There you have it, you now have your business partner and, as long as the business doesn’t succeed or fail things will likely be o.k. However, every business, over time, does exactly one or the other. It either succeeds of it fails.


Good Business Partnership Agreements are All About the “What ifs?”

When you are thinking about a business partner you need to consider many things. Below is a list of outcomes and issues you might want to consider. We’ll go through these issues using Mary and Bill as the potential business partners. To make things easy we’ll assume both are married but not to each other. The issues below are a very short list and the list doesn’t cover all the possible issues. The idea here is for the partners to sit down and talk about ALL of the possible outcomes and what they want to do in those circumstances. Also, just as a point of interest, every item below I have seen (and more than once) in real businesses involving real people:


Issue: Mary and Bill love being business partners, but what happens if, against her wishes, Mary ends up with a business partner that isn’t Bill? How could that happen? What if Bill get’s a divorce and as part of the divorce settlement Bill’s wife Jane get’s Bill’s interest in Skate Blades & Wheels LLC? And then Jane decides her new boyfriend Bubba needs a job and Bubba starts “reporting to work” with Mary every day?


Solution: Have an agreement in the Limited Liability Companyagreement that specifically defines how/if partners can transfer ownership to other parties. You can be very restrictive.


Issue: Mary and Bill get the business plan done and they need to buy $1,000 worth of skates that they can modify as prototypes. But, Mary doesn’t have her $500 and Bill doesn’t either but Bill has $750 open on his credit card and Mary has $250. Who puts in how much? If they are 50/50 partners what do they do?


Solution: The Limited Liability Company (here’s a Hub on LLCs) operating agreement can have a provision whereby the capital would go in as loans and the partners can get their loans paid back before any profits are shared.


Issue: Mary and Bill have been working on this idea for 100 hours per week for 6 months. Things look promising but it will take 100 hours a week for 3 more months to get where they want to be. Bill decides he has to get a job and will only be able to devote 10 hours a week to the business, Mary will have to pull the load across the finish line almost all by herself.


Solution: The operating agreement can state that the additional labor contributed by a partner can be reimbursed to that partner, at an agreed on rate, prior to any profit sharing from the partners.


Issue: It’s 3 years later, the business is wildly successful, Bill and Mary are happy as clams. The have a Christmas party with the employees but driving home some guy falls asleep at the wheel, crosses the center line and crashes into Mary’s car. Mary is in coma and, if she ever recovers, she will be unable to work in the business again. Because of the medical costs the family needs money fast and the family wants to sell Mary’s interest in the business. Bill would like to help but neither he nor the business has the cash to buy out the value of Mary’s interest and Bill doesn’t want Mary’s interest sold to someone else.


Solution: Businesses can buy insurance that will “buyout” the other partners interest in circumstances like this. This type of insurance is commonly called business buyout insurance. Talk to your commercial insurance broker for your options. It is important to have a mechanism in the LLC that states HOW the business value will be determined so that adequate insurance can be purchased. You don’t need to know the value at the time of the partnership agreement if you have a formula to determine the value if the need for a forced buyout occurs.


I could go on forever but the above 4 issues are examples of things to think through. I’m sure you can think of more as well. A good business attorney will also be helpful. You need to take the time to go through the issues and consider the solutions long before you have the problems.


If you have any business partnership concerns or issues please feel free to drop me a question in the comment section and I’ll take a shot at providing a possible solution.


Buying a Business? Due Diligence is Important

Buying a business has many challenges not the least of which is the due diligence process prior to the closing of the purchase. Most small business owners run their business with no thought of selling it. Their record keeping and bookkeeping are done for their needs and there is little or no thought given to how a buyer would view their information.

When buying a business Due Diligence has 4 basic areas of focus. Three of the four require the assistance of the seller:

  1. Industry Due Diligence: The seller is often the worst source for this information. Many small business owners have no real idea of the industry outside the 4 walls of their business. Get what you can from the seller but be prepared to conduct your industry due diligence with outside resources. Most industries have Trade Associations that can be a good source of information. Here’s a link to a Directory of Trade Associations
  2. Business Operational Due Diligence: This is where the seller has the most information. They usually can give you, the business buyer, every detail of the business process. During due diligence focus on understanding why the seller does something their way. Also, you will likely find that the business seller has not documented their processes very well or more likely not at all. When discuss operations with the seller try to take all the notes you can so that you can get focused on the critical areas you need to understand. You’ll have plenty of time later to figure out if you want to change something. Keep in mind that you will be replacing the owner so spending time focusing on what the seller actually does day to day is important. You might want to start a specific list and identify evey seller’s duty – daily, weekley, monthly, annually.
  3.  Financial Due Diligence: This is the wild card. Different seller’s are all over the place on this. I’ve seen million dollar businesses run from a shoe box and $50,000 businesses with perfect accounting. Don’t focus on how they keep their books, just focus on how you can determine from their books if the information is reasonably accurate and you can determine how much money the business is actually making. Most small business financial due diligence starts with bank accounts. Do the deposits made at the bank equal the sales reported for the business? If not, why? Once you pull on that thread it will lead you to other questions.
  4. Technology & Intellectual Property Due Diligence – This is an area of rapidly growing importance. When buying a business make sure that the asset is owned by the seller. there are some obscure laws about who actually owns intellectual property once it’s produced. Also, often I.T. systems are licenses and not assets that themselves can be sold. Do some homework in this area and it could save you some headaches down the road.

We have a saying when buying a business, “There are good businesses with bad books, good businesses with good books, bad businesses with bad books and bad businesses with good books”.  Make sure your due diligence helps you determine which kind of business you are evaluating. Understand the bookkeeping situation but don’t let that automatically disqualify a business for possible purchase.

Keep in mind that your goal is to buy a good business, not just buy a good bookkeeping system.