Business For Sale- Financing the Deal

People who buy a business don’t usually borrow money from banks to finance the deal. Banks have very rigid guidelines on whom they can lend to and in what circumstances so, as far as possible, buyers try to find alternate means of financing. A common form of financing when buying a business is Seller Financing where you, the seller, provide part (or all) of the financing, which the buyer pays back over a period of time. There are no set terms for a seller financed deal; the specifics of each deal are worked out between the buyer and the seller.

Seller financing is a huge advantage to the buyer, since you will be less particular about lending criteria and terms of payback, than a bank. The seller can also obtain tax benefits if the deal is structured as an installment sale. Further, since the terms are flexible, you can allow for a floating interest rate, where the rate of interest increases with time.

How To Go About It

The buyer makes a down payment, and the business itself (or its major assets) provides the collateral for the rest of the payment. You have to then file a lien with the office of the secretary of state, so that the deal is recognized. Then. in the event that the buyer fails to meet the terms of the payment, you will be entitled to repossess the business.

There are a few things to consider before you decide whether or not to finance the deal yourself .

1. How much of the deal are you financing?

If you are financing the entire deal, then the right to repossess the company if the buyer defaults on payment, rests with you. However if the buyer is borrowing most of the money from a bank and only the remainder from you, your business will probably provide the collateral for the bank’s financing, and not yours. So the bank will be entitled to take possession of the company if the buyer defaults. In this case you should insist on a higher interest rate for yourself and if possible, a say in the functioning of the company after the sale. To have the buyer run your business aground, and then watch it taken over by the bank is obviously not a position you want to find yourself in. With a position in the company, even if not a crucial decision-making one, you will be able to ensure that the business runs smoothly.

2. What is the period of repayment?

The terms of the deal (down payment, interest rate, period of payback etc.) usually favor the buyer in a seller financed deal, so the seller needs to make sure that her interests are secure. The down payment is followed by the period of repayment, but often, instead of having the buyer repay the entire amount over time, she ends payment with a lump sum which maybe procured through bank financing. This is beneficial to the seller, since it means the buyer has to work to make sure that the business reaches a position where obtaining bank financing to repay you won’t be a problem.

3. What collateral is being provided?

Ideally the primary collateral will be the company itself. In that case, in the event that the buyer defaults on payment, you can repossess the business and look for another buyer, or if your situation permits, resume ownership of it. If this is not possible, then the buyer can be required to provide an alternative collateral, such as a personal residence, real estate holdings and other secure investments.

It is standard for the buyer to take out a life insurance policy which cites the seller as the beneficiary. That way, in the event of the buyer’s untimely death, the loan is still repaid. If the buyer herself is going to be the driving force behind the company, then taking out a disability insurance policy (although very expensive) can protect your interests even further.

4. What role will you play after you sell the business?

Even if you don’t play an active role in the management of the company, you might want to include terms in the deal that permit you to review the performance of the company, since the buyer’s ability to repay you will depend on how well the company does. For example you can ask for access to quarterly financial reports, which will give you a good idea of how your business is being handled.

The deal will include terms that protect your interests without you having to hover around after the sale. These might impose limitations on how many changes she can make in the running of the company, what assets she can sell etc. The buyer should not be permitted to take too many big risks as long as she is repaying you. Plans like expanding the company should ideally wait until the repayment is complete.