If you are planning to buy or sell a business, one of the most creative financing options is seller financing.
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Though it may sound intimidating to both parties, there are ways to utilise this option to benefit both parties. Seller financing is where the seller of the business would allow the buyer to make part of the payment at a future date, in return for some kind of security. This helps to close a deal faster with sellers getting a higher return on the agreed money while buyers can leverage the time they have to get the rest of the finances together. This mode of financing is similar to how bank loans operate where the seller can be treated as the money lender or the bank.
As a buyer, you need to first analyse the business you intend to buy. Try to get answers to questions like- why is the other person selling this business, how strong are the finances of the business on sale etc. If you feel is the business is just undervalued and is worth taking a risk, ask the seller to provide seller financing. This is a bond of performance. In other words, it is a guarantee for the business given by its former owner himself. It is proof that the seller is not unsure about the future of the business.
It will also prevent the buyer from taking a bank loan at larger interest rates. By not waiting for a bank loan, you can also speed up the process of buying the business and running it. The rest of the money can be invested in other profitable areas to get a better return on investment. If the business goes well, interests payments can be done from the profits of the business itself. You can also work out a comfortable repayment schedule with the seller.
As a seller, one of the major reasons to offer this option upfront is to attract buyers and close the deal faster and at an attractive price. Also, though you may not be paid the entire amount in one go, you end up getting interest on a regular basis. This works like a bank loan for you, with you playing the role of the bank. There would also be tax benefits as capital gains are realised with time.
However, in most cases, sellers are reluctant to offer this type of financing, especially when the buyer is an unknown person, as there is some risk involved. To avoid this risk, sellers mostly ask for some security or collateral from the buyer. This guarantees that the buyer is willing to risk his assets to pay for the business. Sellers must be cautious to offer this to people who are reluctant to mortgage their assets to avail the option of seller financing. Some risk can be mitigated by asking for a larger down payment, so that the buyer does not abandon the sale by giving a nominal initial payment.
Although the disadvantage of seller financing is the risk involved for both parties, if properly negotiated and employed, this source of financing can prove to be a win-win situation for both the buyer and the seller.