Seller Financing 101

What is Seller Financing?

Seller financing is exactly what it sounds like – financing provided to someone purchasing a business by a Seller of a business. It’s in essence a loan provided to the new owner of the business (in place of a loan from a typical bank), which is secured by the assets of the same business. The advantages to the buyer and seller can be significant, which is why x10 advocates to our clients heavily to utilize seller financing. . . wherever possible it should be a component of the deal!

Why do I say that? For the simple reason that the when a Seller is betting on your success, and the relationship starts off with the ‘symbiotic synergy’ that Seller financing provides, there’s a better opportunity for a good outcome. The Seller would likely NOT be offering you a loan if they did not believe in your prospects of ongoing success in the business (a vote of confidence in some ways). Regardless of the terms of the financing, the Seller is more invested in the outcome IF their monthly/quarterly/annual check is coming from the business; as a result with capable and qualified buyers these deals are more likely to have a good outcome.

From the Seller’s perspective, Seller Financing makes sense as an investment in the ongoing business, secured (ideally) by a motivated buyer that’s eager to grow the asset. This can be a ‘deal enabler’ in that there’s far less opportunity for a 3rd party to cause delays in the deal’s closing date if a bank and underwriting are not involved. Not only can the deal potentially close faster, the expected closing costs for the deal would be far less if the financing comes through the Seller; as the promissory note and security agreement are relatively simple documents to draft. One of our best in-house deals was a two week turn from first call (same day letter of intent!) to closing day in another state and that was only possible due to the Seller Financing component (about 60% of the total deal) and no need for bank approvals.

“YOU DO NOT NEED 100% DOWN TO BUY A
BUSINESS-CREATIVE BUSINESS
FINANCING IS AVAILABLE!”

Switching gears to the Buyer’s perspective, Seller Financing provides a host of benefits including stronger potential leverage (be careful here, more on that later…) for their capital. A Seller may be willing to offer more financing to the Buyer than a bank would and under potentially better terms. If the Seller finances the business versus the Bank, and the note is structured as a long-enough term, then existing acquisition funds can be repurposed for runway/operating expenses for the business, or capital equipment of other strategic investment. A Bank could also provide a line of credit for operating expenses, in addition to the longer-term Seller Financing.

On the risk side, as long as Sellers maintain the proper security agreement (normally covered well by all assets of the business being acquired) the downside risk is the potential hassle and expense of repossession and foreclosure on the business asset if the buyer is not able to make the required payments. It’s exceptionally rare for the Seller to require a Personal Guarantee from the Buyer, and if it’s required is this really a great deal?

Addressing risk on the Buyer side, while it’s also rare that a Seller would get back into the same industry and start competing with the business they just sold, a Non-Compete agreement is an essential part of the closing documents. It’s essential that the Non-compete term is as-long or longer than the Seller Financing term. Why? For the simple reason that you would not want to be making payments on the business while the seller is now permitted to go into competition with the business they just sold!

With any business, financed via a traditional bank or through seller-financing, leverage needs to be managed. I’ll highlight the importance of this with a real world example from early in my career. . . One of my first employment situations was for an entrepreneur who had recently acquired the business and hired me, fresh out of college, to be the General Manager. What I did not realize is that in addition to crushing it on the sales side growing accounts from the get-go, my Friday AM routine would be negotiating with the new owner over which vendors needed to be (and thus would be) paid out of our limited cash flow. I didn’t think this was the way things were supposed to go!

IF YOU’RE LOOKING TO BUYABUSINESS,
SELLER FINANCING CAN BE A GREAT OPTION
THAT OFFERS LOTS OF LEVERAGE – AS WELLAS
FLEXIBILITY, SPEED, AND THE ABILITY TO CLOSE
THE DEAL MORE OUICKLY”

It turns out not only had the new owner (my boss) significantly leveraged the business with Seller Financing (around a $6k/month payment on starting revenue of about $50k/month), he also had a number of ‘friends and family’ and ‘other businesses’ that needed to be paid back out of the company proceeds as a priority along with the seller note. And while this position ended up being a wildly successful experience for me (I was able to double annual revenue within 12 months to $1.2mm and we successfully acquired another company), that experience taught me two valuable lessons:

• 1) You DO NOT NEED 100% DOWN TO BUY A BUSINESS – creative business financing is available!
• 2) A Business can be OVER-LEVERAGED to the point of being nearly unviable as a going concern.

While not ideal, you could probably figure out how to make $6k payments on a business doing $50k in revenue per month if the margins are healthy and there are other opportunities to lean out the business. For example, if you can find a 25% reduction in Operating Expenses, you could completely mitigate the seller loan payment and it could have no ‘net effect’ on the business. That could open up room for expansion or investment in other key areas of the business, or ultimately open up possibilities for another bolt-on acquisition to grow revenue, services, or your geographical footprint. Now we’re starting to get a broader picture on the leverage opportunities that seller financing can provide as an investor.

In summary, if you’re looking to buy a business, seller financing can be a great option that offers lots of leverage – as well as flexibility, speed, and the ability to close the deal more quickly. Offering numerous benefits to both the buyer and seller, we’d like to see more deals ‘enabled’ with Seller Financing (but watch the overall deal leverage!)