Carryback financing can dramatically increase the number of potential buyers for your business and improve its value on the open market.
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But if you're not careful, it could also lead to financial losses, legal entanglements, and years of headaches you could live without.
A carryback note is a promissory note signed by the buyer, agreeing to repay the non-cash portion of the sale at a specified term and interest rate. Many buyers – especially first-time business owners – are interested in obtaining seller financing either because they don't have a track record in business or because they lack the downpayment required by traditional lenders. In an ideal situation, financing can benefit both the buyer and the seller. However, since sellers assume most of the risk, you should approach a self-financed sale with caution.
There are a lot of reasons why sellers finance the sale of their business. The best reasons involve a well-thought out plan that expands the business' marketability and provides interest income for several years after the sale is completed. But too often, the motivation behind financing is less sound. When sellers are backed into a corner – either by the buyer or by pressure to sell the business – seller financing suddenly becomes a quick way to unload the company. The end result is a shoddy arrangement that falls short of the seller's goals.
Buyers approach carryback financing as a shortcut to business ownership. Unable to muster an adequate downpayment from other sources, they look for an owner willing to finance all or most of the purchase price. However, smart sellers know that the downpayment insulates them from losses if the buyer is unable to fulfill his obligations. The standard downpayment for carryback financing is 30%.
Carryback financing is an investment, but because it involves more risk than putting your money in a mutual fund, it should carry a respectable interest rate. The average interest rate for carryback financing is around 8%, although that can fluctuate a bit depending on the size of the loan and other factors. Be careful if the buyer insists on a high interest rate to sweeten your incentive for you to finance the deal. A buyer who agrees to pay an exorbitant interest rate probably doesn't intend the repay the loan in the first place.
Business loans are not like residential home loans, even if they cover real estate assets. While home loans are typically repaid over a period of twenty or thirty years, business loan terms – especially carryback financing terms – should go no longer than five years. If the buyer is unable to repay the full amount of the loan before that time, he should have enough equity in the business to refinance through a traditional lender.
Due diligence of the buyer is a must for seller-financed business deals. In addition to researching the buyer's credit worthiness, you should also take an interest in the buyer's background, business plan, and personal references.