Becoming a business owner is a worthy goal. But sometimes, starting from the ground up is not always doable.
Buying an existing business gives you the chance to be a business owner without the hard work of starting a company. In 2016 alone, 7,842 small businesses sold in the United States. And many of those purchases were funded through a mix of alternative financing and traditional business acquisition loans.
But finding and qualifying for a business acquisition loan can be almost as difficult as starting the company itself. Luckily, there’s an alternative to traditional small business loans: seller financing.
Seller financing for business acquisitions allows buyers to purchase a business without relying on a bank-issued loan alone. But there are some critical key differences between the two.
Here’s what you need to know about seller financing and what it means for both buyers and sellers.
What is Seller Financing for a Business Acquisition?
Seller financing for business acquisitions is a type of loan option only sellers can offer. Instead of forcing the buyer to work with a traditional lender to finance the purchase of the business, the seller provides a loan directly to the buyer.
These loans are typically enough to only cover a portion of the purchase price rather than the full cost. But they can take some of the stress out of the buying process for would-be business owners.
How? Well, because small business acquisition loans, even ones backed by the U.S. Small Business Administration (SBA) can be challenging to get. In many instances, buyers only qualify for a loan that covers a portion of the purchase price, but not all.
This means buyers have to find alternative lending options to cover the rest of the asking price.
Seller financing fills that role perfectly. Best of all, it gives the seller and buyer more control over the acquisition.
How the Loan Process Works for Sellers
It’s up to the seller to decide whether offering financing is in their best interest. If you need to sell the business as fast as possible, offering seller financing can help speed the sale up.
If the seller decides to offer financing to potential buyers, they can include this information in the listing. Once extended, the seller assumes the role of the bank.
The loan terms are theirs to decide. If they want the financing term to be short, it can be. If they need a higher down payment to secure their investment, they can ask for it.
The buyer has to meet the terms of the seller’s financing agreement. If they can’t or won’t, they need to find another loan option.
Once the buyer fulfills the loan agreement terms, the seller’s interest in the company ends. Their investment should be covered in full with added interest paid each month during the financing term.
Keep in mind that sellers are never required to offer seller financing.
Why Sellers Might Offer Financing
Financing makes the business acquisition a bit more attractive to buyers. This means they can sell the business more quickly than they otherwise would be able to.
The more buyers interested in the company, the better. More interest means better offers. And better offers mean more money in their pocket.
This protects their interest in the business and helps them recover some of the money they put into the company in the first place.
But there are some risks involved. When a seller finances the acquisition, they run the risk of the buyer defaulting on the loan. Unlike a traditional bank, they don’t have the financial resources to eat the loss.
How the Loan Process Benefits Buyers
For buyers, the seller financing loan process is relatively similar to one with a traditional term loan.
The buyer is still required to put a down payment on the business. The seller may also ask them to meet certain credit score requirements to qualify for the loan in the first place.
But unlike traditional term loans or business loans, there’s more flexibility in place.
The seller understands that buyers won’t always have cash up front to buy the business. So, they issue the loan based on how the business has performed for them. If the company is turning a profit, it will likely continue to do so with the new owner.
This means the downside is minimal and they may be willing to work with you even if a bank denies your application for a standard loan.
The flexibility essentially kills two birds with one stone. The seller finds someone to purchase their business faster, and the buyer gets to become a business owner immediately.
Best of all, it allows buyers that otherwise might not qualify for bank loans to become successful.
You Still Need Additional Funding
Seller financing won’t cover the full cost of the business acquisition. It’s too risky for business owners.
But it can reduce the amount of money you’ll need to take out in traditional business loans. If the seller offers financing, make sure you understand how much they’ll let you finance.
If the loan amount is not high enough, you’ll want to apply for traditional term loans to make up the difference.
Regardless of the types of requirements the seller expects you to satisfy, you’ll need to qualify for the traditional loan in the first place. In most cases, this means you’ll want a credit score higher than 600. You’ll also want a good payment history on both personal and business debts and bills.
What to Do to Improve Your Situation
If your credit history is less than stellar, now might not be the best time to buy a business on your own. You can work with a business partner to help offset lower credit scores. Or you can build your credit back up over time.
If you choose to build your credit score, start working on paying down existing debts immediately. Make sure you pay your monthly bills on time, every time. And check your credit score for errors once a month.
Should any errors pop up, notify the credit bureaus and report them immediately.
What You’ll Need to Do to Apply for Owner Financing
No matter what combination of financing you’re using to purchase the business, you still need to prepare. And there’s more to getting financing than merely expressing interest in a seller’s business.
Business Plan
Seller financing means the seller is putting their money on the line by offering you the chance to make monthly payments. This means they’ll want to make sure you’re prepared to take over the company.
Put together an in-depth business plan to show that you’re capable of at least maintaining the business. This will give the seller more confidence in working with you.
Research the Seller
Ultimately, you’re going into business with the seller until you own the company outright. You’ll need to make sure the business is worth buying in the first place.
Ask for financial statements. Interview the seller about what worked, what didn’t, and where the business seems to struggle. Take the time to know what you’re getting into before ever agreeing to the business acquisition.
Have a Down Payment Ready
With any business acquisition loan, you’ll need to have a down payment ready before you qualify for financing. But with seller financing, that down payment is even more important.
Most sellers ask for a higher down payment when they’re financing the sale for you. This helps protect their investment and gives them immediate cash as they’d receive from standard bank-financed deals.
Before agreeing to the seller financing deal, make sure you can cover the down payment. If you can’t on your own, consider working with a business partner or asking for a small low-interest loan from friends.
Clarify Interest Rates
Most seller financing deals require buyers to pay a higher interest rate for the term of the loan. This is because the seller assumes all of the risk. They don’t have the same backing as traditional banks and won’t have access to funds to offset the loss should you default on the loan.
Before you agree to the deal, make sure you understand the interest rates they’ll charge. If they’re too high, you may want to keep looking for traditional term loans to make up the difference. Paying interest on multiple smaller loans from different lenders can save you money if you qualify for them.
Shop around, get quotes from different lenders, and make sure you’re making the right choice in working with a seller to finance the sale.
What the Seller May Ask for in Return
As we said before, sellers financing the sale on their own assume the risk of the loan. This means they’re free to ask for different things in return to secure the loan. Here’s what you can expect:
Collateral
Sellers can ask you to list the business as collateral as part of the financing terms. Often, they’ll share a lien on the company with whatever bank you choose to fund the rest of the purchase with. This is done with a UCC blanket lien which gives the seller control over their portion of the loan.
Maintaining Inventory Levels
Until you pay off the financing deal, the seller can expect you to maintain certain business practices. In most cases, this is used to manage inventory levels. They want to know that if you default on the loan and they resume control of the company, they can pick up where they left off.
The last thing a seller wants to do is spend a ton of money replenishing inventory that wasn’t well-managed. Once you pay off the financing deal, you’re free to keep inventory at whatever levels you deem best.
Control of Business
As a condition of the seller financing the sale, they can demand that they retain control of the company if you default on the loan or miss loan payments. Most control clauses will include a grace period. After all, accidents happen and when you’re new to running a company, things can slip through the cracks.
But if you continue to miss payments or default on the loan, most sellers will include a provision that allows them to take over the business within 60 days of the missed payment.
This helps keep their financial interest safe and preserves the company they started. As with all loan terms, the provision goes away once you pay off what you owe the seller.
Once their portion of the loan is repaid, the only provisions you need to worry about are the ones maintained by your traditional lenders.
How to Get Seller Financing for Business Acquisitions
Most sellers who are willing to finance part of the purchase price will advertise their willingness. Look for businesses that openly state they’re willing to discuss seller financing.
If you can’t find one that advertises financing options, don’t be afraid to ask. Remember, business acquisitions are just another type of sale. Negotiation is part of the process.
And many sellers, especially those that have been trying to sell their business for months with no offers, are willing to explore the possibility.
Know Your Financing Options
Seller financing for business acquisitions is only one type of financing available. And for most buyers, it won’t be enough to cover the full cost of the company.
But that doesn’t mean you won’t be able to find the funding you need. Contact us for more information on our small business loans and see how we can help turn your dreams into reality.
Whether you’re looking for standard term loans or need help finding alternative options, we’re here to help.