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
Seller provided financing opens the sale up to a wider range of buyers (though not necessarily higher quality buyers).
Without a 3rd party lender (SBA, Bank, etc) the deal can likely get to closing faster than if bank financed
Buyer usually isn’t as price sensitive since there usually isn’t a 3rd party valuation
You may be able to cross-collateralize or obtain cross default agreements to tie up assets.
If you get a personal guaranty from buyer you may have better chance to get paid.
If the buyer defaults on the note it can be expensive to try to collect
If you worry as much about the note payment as you did about the business are you any better off?
Unless done properly there can be all kinds of tax issues
The Uh, Oh:
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.
Get the landlord subordination agreement at the time of the sale.
If you can, cross default the lease and note so that if buyer is in default on either they are in default on both.
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.
Try to get a really high default interest rate on the note so that the financial pain of default is high.
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.
Try to get collateral other than business assets. Does buyer have a vacation home? Other assets?
Guarantors – get as many guarantors as possible also make sure spouse signs guaranty if required in your state.
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 Bank is likely to screen the buyer more thoroughly than most sellers
The seller note is likely to be less than 10% of the total selling price.
The bank will look very carefully at the business cash flow (several years), seller financials need to be in good order.
Bank will require a 3rd party valuation to make sure the price the buyer and seller agreed to is fair.
SBA limits any “after the sale” arrangements between buyer and seller.
The seller note will likely have a period (usually 2 years) whereby the seller gets NO payments and only interest accrues.
If buyer defaults on seller note the Bank will limit what actions the seller can take to get paid.
The Uh, Oh:
Because of the restrictions in the bank subordination agreement the seller note is usually the first obligation that goes unpaid.
If the seller stops paying you it’s usually a sign of other significant problems with the business.
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.)
A revolver is flexible in that if funds cashflow when the business is growing.
A revolver usually has fewer covenants.
The “credit worthiness” of the business is less stringent than normal bank standards
The seller note will lose a/r and inventory as collateral.
The revolver lender usually can “pull the plug” at any moment
The cost to the borrower can be significantly more expensive than an SBA term loan.
The Uh, oh:
Revolver loans normally have many fees and opportunities for lender to squeeze a few more dollars out of borrower
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 financing, it can get expensive quickly.
If you have high volume of regular credit card sales these loans are not difficult to obtain
The cashflow is steady
These loans can be very expensive
The CC lender gets paid before the seller note by taking their money out of the sales revenue.
The Uh, oh:
Because these loans have a claim on all revenue it is very unlikely any other 3rd parties would provide financing.
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.
Mr. Elliott is Managing Director of Sunbelt Texas Business Sales & Acquisitions with more than 20 years experience in mergers, acquisitions and business broker. Mr. Elliott purchased Sunbelt Houston in 1996 and has managed the sale of over 500 companies from very small businesses to companies with revenue of more than $30,000,000. Mr. Elliot has provided Business Broker and merger and acquisition adviser services to privately held business in Houston, Austin, San Antonio and throughout Texas.
Over a 20 year career, he has handled a wide range of industries including manufacturing, distribution, medical, machining, construction, and contractors. Mr. Elliott has completed transactions with Private Equity Groups, strategic buyers and a wide range of regional companies executed plans to grow through acquisitions.