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Signing a Contract

Seller Financing

Ideally, for a Seller, full price cash closings would usually be the best alternative for a Seller.  However, in the process of selling a business, it is important for the seller to consider alternative financing options for certain purchases.   In some instances, a “great fit” candidate for purchasing the  business may not readily have the required capital to pay for the purchase in cash.   Seller Financing, at times, can ensure that the most qualified candidate can be the eventual purchaser and can result in a higher purchase price. 

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What Is Seller Financing?

Seller financing is when the Buyer, as part of their consideration for the purchase receives financing from the Seller.  This will usually be in the form of a secured or unsecured promissory note from the Buyer.  

 

Seller financing is different from an Earn Out Agreements or Hold Back Agreements.  In Seller financing the Buyer has an obligation to pay the Seller represented by a Promissory Note.  

 

An Earn Out Agreement is when part of the financing is contingent on the Business achieving certain agreed upon milestones after closing of the Purchase.   Earn Out Agreements are contingent payments.  

 

Hold Back Agreements are when some of the consideration to the Seller is held back to account for reconciling or claim items which are the responsibility of the seller and will have an agreed date to “true up” or reconcile the amounts due to or from the Seller.  

Secured vs. Unsecured Financing

Secured financing in the context of a Business Purchase will consist of a Promissory Note or Notes from the Buyer in favor of the Seller secured by a Mortgage on Real estate or a Security Interest in the Accounts, Personal Property, Receivables and other assets of the Business.  This will customarily be accomplished by a Uniform Commercial Code Financing Statement (a “UCC- -1 Financing Statement)   A UCC-1 puts the world on notice that some or all of the assets are subject to a security interest.     In a Secured transaction the Seller in essence is taking back a Note and Mortgage on the Business.   The Seller becomes the Bank for the Buyer.  

 

A Mortgage on real estate would be recorded in the Public records of the county in which the property is located.  UCC-1 Financing Statements are recorded in a state registry that is publicly available.  In Florida, for example www.FloridaUCC.com is the central registry for UCC financing.  


 

Unsecured Financing would more often be utilized in a case in where the Buyer is bringing cash to the Closing and has third party financing that already has security against the Assets of the Business.   An example would be when a Purchase price is $3,000,000, the Buyer is bringing  $1,000,000 in cash, and has bank financing for $1,800,000, unsecured seller financing in the amount of $200,000 could be used to bridge the gap to the purchase price of $3,000,000.   

When To Considering Seller Financing

The most important factor in considering seller financing is your analysis of the Buyers ability to be able to meet the obligations of any Seller financing that is contracted between the Buyer and Seller.   

 

A Buyer that the Seller believes otherwise has the skill and resources to operate the Business successfully in order to repay the financing would be a good candidate for Seller financing.  Secondly, a Buyer that has resources invested in the transaction is much preferred.  From the Seller’s standpoint, you want a substantial investment from the Buyer.  As a Seller you would not want a Buyer that does not have his or her own funds at risk in the purchase.   

 

Seller financing may enable the seller to obtain a higher price for their business as the potential buyer pool will be larger.  A Buyer may be willing to pay a higher price if they are able to expedite a closing with Seller financing.    

 

In summary, the deal should make sense financially to both parties.  That means making sure that the Buyer has adequate working capital to support the business after the closing and to make the payments to the Seller.   In most cases the Seller should be able to evaluate the cash flow of the business that they are selling to determine the likelihood of the Purchaser’s ability to make the payments.  

Business Signing Contract

Example of Seller Financing

A bar owner has run a bar and restaurant for the past 8 years.  The income from the Bar restaurant has averaged about $300,000 per year and the bar has 3 key employees that run the Bar.   The Employees don’t have great credit but do have enough capital for a significant down payment.   

 

Solution:   The Seller sold the business for $1,200,000 with $300,000 down and $900,000 on a 4 year promissory note, payable at 5% simple interest (attractive financing).  The Buyers execute a promissory note for $600,000 payable over 4 years, with a monthly payment of $16,984 per month.  The Note is secured by a UCC-1 Financing Agreement covering all the assets of the Bar.  The Seller and Buyer amend the Lease with the Landlord to extend out for 19 years with a provision that should the Buyer default the Seller has the right but not the obligation to step into the shoes and take over the lease.   

 

Why this works:  

(1) Buyers had significant capital of their own invested 

(2) The Seller knew the Buyers and had confidence in their ability to operate the business

(3) The Seller knew that the Business could generate enough income at present to satisfy the note obligation and still leave over $100,000 in profit for the new owners as cushion against any shortfall.  

(4) The Seller received another $119,000 in interest over the 5 years  (5) The Buyers were able to purchase a good business that they could not otherwise qualify for and

(6) The Buyers were able to establish good credit for the business by making the payments and

(7) The Seller was secured in the case of a default by the Buyers.   

Pros and Cons of Seller Financing

Seller Advantages:

  • Makes more deals/closing possible

  • Increases Pool of Potential Buyers

  • Usually faster closing time

  • Can facilitate a Sale to Employees or second generation  

  • Can result in a higher purchase price

  • Possible tax advantages in spreading out Purchase Price vs. receiving entire Purchase Price at once.

  • Steady Stream of Post Closing Income

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Seller Disadvantages:

  • Waiting on portion of Sales Price

  • Risk of Default by Buyer-Seller is banking on the success of the Buyer in the Business.

  • Buyer more likely to find “problems” post closing if funds still owed

  • Seller may have to take business back over in case of default

  • Requires more upfront work by the Seller to ensure that the Buyer has the right operational capability,  capital,  and business experience to make the payments to the seller.   

  • Requires more time and investment by the Seller. 

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Buyer Advantages:

  • Buyer can Purchase a larger business with same Buyer funds

  • Can be easier than traditional financing

  • Faster closing time

  • Less Capital Required/Lower Down Payment

  • Interest is deductible 

  • Gives the Buyer some leverage if issues arise post closing

  • Interest rate can be lower and/or lower fees associated than with bank financing.

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Buyer Disadvantages:

  • Potentially higher interest rate than traditional financing

  • Obligations to Seller while running business

  • Seller may have security interest in business

  • Buyer “looking over” shoulder while obligated to Seller

  • Possibility of foreclosure by Seller in case of default by Buyer

  • Buyer may have personal liability to Seller (Personal Guaranty)

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