Your willingness to offer seller financing can greatly increase the likelihood of a successful sale, but seller financing has its risks. Under the right circumstances, it can be a financial boon, but sellers need to be aware of the pros and cons.
Pros For Sellers:
Cons for Sellers:
Typical Seller Financing Terms
Each seller has a different mindset of what they want to get out of their business and when they need the cash for the sale of that business. However, there are some commonly accepted terms that can be a good rule of thumb when looking to negotiate seller financing. Terms for seller financing will commonly include:
How Sellers Protect Themselves
Since you’ve been running the business for some time, you’re probably confident in its ability produce income in the right hands. What you don’t know is how well your buyer will perform. Therefore, protections are put in place to protect your interest during seller financing. These protections may include:
Control of Business for Non-Payment
These are terms that state a seller will give the business back in the
As a seller, you will want to file a Uniform Commercial Code, or UCC lien on all business assets to secure your interest as a lender. This notice states that your buyer owes you money and that their assets are pledged to you as collateral. Note: you will take
Minimum Inventory Levels
Sometimes, for businesses with large amounts of inventory, it's wise to include clauses in your contract that require the buyer retain a minimum level of inventory. This is to protect sellers from being left with no inventory in the event they have to reclaim the business due to a buyer default.
Expenditure & Financing Restrictions
Sellers may also restrict how buyers can spend and/or how much additional financing they can receive while still repaying the financing for the purchase of the business. Typically, buyers will be restricted from spending more than 1-3% above the seller’s largest expense period while they ran the business.
Don't write off the possibility of seller financing in your deal. It can be a great way to cover any financing gaps the buyer may have, and it allows you to stay plugged into the business to ensure its success following a sale. - Jeffery Baxter, President
There are many types of SBA loans, but the most common and relevant to business sales is the 7(a) loan program.
Because the SBA stands behind the loan in the event of a default, loan approval is somewhat easier. The process, however, often takes longer because the borrower must be approved by both the SBA and the lender.
While buyers are the ones who need to obtain the loan, it’s important for sellers to understand what the lender and buyer are evaluating.
Why Many Buyers Utilize SBA
Conventional bank loans are rarely available for business acquisitions, and SBA loans are generally the least expensive sources of capital available to a buyer due to their competitive interest rates and long repayment terms.
It’s usually easier to get approved for SBA financing when buying an existing business compared to getting approved to fund a startup. This is because the lender can better judge the buyer’s potential to repay the loan by looking at their potential business’s track record.
Terms & Costs
Typical rates, fees and repayment terms:
What Your Business Needs to Have
Before a lender even looks at the buyer's information, they’ll want to see if your business qualifies for financing. Your business will need to have a strong financial track record, as well as clean and orderly books. Three years increasing revenues and cash flow is ideal.
You will be required to provide the last three years of business tax returns, three years of profit and loss statements, a copy of the lease, interim profit and loss statement, and a balance sheet. If there has been a decline in revenue or cash flow over the past three years, the lender may require a letter of explanation.
Even though all lenders must abide by the SBA SOP’s, each lender has the right to be more restrictive in its own procedures. Often, SBA lenders will request an inventory list, an equipment list, aged receivables report, etc.
Seller Financing in SBA Loans
If a buyer doesn’t have sufficient cash savings to fund an SBA deal, the buyer can seller finance part of the loan. Most owners would rather cash out to have funds available for their next venture, but there are some advantages to seller financing.
For one, seller financing can help more buyers secure an SBA loan, opening up the potential pool of qualified buyers. Seller financing also gives both the buyer and the lender more confidence in the business, since it shows the previous owner is willing to take more risk.
Seller financing may also increase the sale-price of a business, since it is requiring the seller to take more risk.
Keep in mind, when seller financing is used alongside SBA financing, the seller must be willing to take a “standby” position for 2 years and subordinate to the SBA lender. This means you won’t receive payments on the loan for the first two years (or will receive interest-only payments), and if the loan defaults, the SBA lender is in first position on proceeds from the sale of assets or collateral.
Advantages of SBA for Sellers
Disadvantages of SBA for Sellers
By utilizing an SBA program and lowering the required down payment amount to as low as 10%, you increase your pool of buyers and drive up the competition to acquire your business. - Steve Mariani, Diamond Financial
The SBA guarantees a portion of the loan. The buyer pays an SBA loan fee that allows him or her to get funding for a loan the bank couldn’t do conventionally. If an SBA guaranteed loan goes into default, the SBA will pay the lending institution up to 75 percent of any deficit left after liquidating the collateral.
A buyer and the lending institution must evaluate a company’s cash flow and determine if it is adequate to cover their debt service and provide a reasonable return on their investment. Lending institutions will also be examining whether a buyer’s coverage ratio or excess cash flow after all debt is paid, is adequate to cover their needs. They will also evaluate a buyer’s ability to successfully run the company, based on their experience and their plans for the future of the business.
What Private Equity Firms Look for in an Investment
Private Equity Groups search for companies with solid management teams, solid and recurring customers, high margins, strong balance sheets and an ability to generate significant free cash flow.
The best candidates are private companies that are experiencing rapid growth, hold a leading position in their industry, have significant barriers to entry for competitors, and sell a differentiated product or service that commands a premium over the competition.
Typically, lower middle market private equity funds set a minimum level of EBITDA (Earnings before interest, taxes, depreciation, and amortization) such as $1, 2 or 5 million, but within the past few years, some smaller search funds have lowered their threshold and will review companies with an EBITDA above $500,000.
What Private Equity Firms Offer
PEGs may bolster the existing management team by replacing or adding specific positions such as a CFO to manage the company's financial affairs, improve operating procedures and internal controls, and serve as the financial representative when the firm is looking to sell the investment. PEGs also offer a source of liquid capital, resources, and industry expertise to help increase the value of your business.
A Private Equity Group is Right for You If:
How to Evaluate a Private Equity Group
It's essential for you to choose wisely if you sell a stake
Evaluate the PEG’s track record and ask to speak with owners of previous companies the PEG has acquired. Be sure the PEG’s plans and projections are realistic. With over-ambitious plans to expand the business, it may overstretch the business. It’s also important that your management team’s future company goals align with the PEG’s goals.
Remember, the key isn’t necessarily to select the private equity group offering the highest price for your business today. Instead, look to partner with the group that will provide you with the opportunity for the highest overall proceeds. This would include the amount received initially and the amount you can reasonably expect in the future when the business is sold.
Selling to a private equity group is an excellent option for any seller looking to stay engaged in their business following a sale. - Chad Barbour, Senior Advisor