Finding the right buyer for your business is not an easy task. Unfortunately, that person that you know—deep down in your soul—is the right one to take over your business, may not be well funded. This is where seller financing can save the day.
Seller financing is when your buyer agrees to give you an initial deposit for your business and pay the remaining balance in installments (usually) for the next five to seven years. It’s a simple and creative way of helping the ideal buyer for your business to get the deal done.
As a serial entrepreneur, I know seller financing. I’m also a big proponent of it if it helps you to find the right buyer. Consider the five steps involved to help you in your decision-making process.
Step #1: You and the Buyer Agree on Terms
Terms to consider in your deal include the downpayment, interest rate, collateral, and anything else you can think of that might be necessary. In most cases, the business itself is the collateral. If the buyer defaults in that situation, you can reclaim the business.
Additional collateral is also an option. If your potential buyer’s credit rating is poor, you can ask for other property and assets in the even of default. Of course, a poor credit score can also be a dead-red indicator that this person is not the right buyer.
Step #2: The Downpayment
Since the repayment terms are shorter than something like a mortgage, the buyer should put down at least 25 percent of the purchase price. Some buyers may want to put down more than this amount, depending on their own financial situation. The more cash you can get upfront, the less risk you assume, so if the buyer wants to put down 35 percent or more, take it!
Of course, 25 percent can still be a large sum of money depending on the sale. If the buyer doesn’t have at least this amount, however, this is another indicator that your potential buyer may not be the right fit.
Step #3: The Promissory Note
This is the agreement that binds the buyer to the proposed installment plan. Once the buyer signs the promissory note, ask them to do the filing as well. After all, you’re taking all the risk in this situation, so you’re 100 percent justified in asking the buyer to do the administrative work.
It’s always a good idea to have a lawyer looking over all the details of financing, but the promissory note is a legal contract, making it especially important for you to have a lawyer make sure the terms of repayments are clear and meet your demands.
Step #4: The Buyer Makes Regular Payments
While the buyer repays, the business is under their control. If they run your business into the ground or don’t make as much money as they thought they would, they might be unable to repay. You’ll then have to go through the courts to reclaim your business and assets.
If you did your homework before agreeing to seller financing, the chances of this happening are relatively low. Before even considering seller financing, you should have qualified the buyer. As a business owner, you likely know who is financially suitable to buy your business. Of course, it doesn’t hurt to run each candidate by your legal team.
Step #5: The Balloon Payment
The final payment is called a balloon payment. This is usually a larger amount than the other installments. Ideally, this final installment is a mere formality, and there were no rocky roads to traverse during the installment period. This way, both buyer and seller part ways on highly amicable terms and maybe even form a supportive business relationship moving forward.
This is the day when everybody gets what they want. The buyer is no longer indebted to you and you can officially move on to the next phase of your professional life. If you’re a serial entrepreneur like me, you’ve probably already begun work on other projects. Take the balloon payment and invest accordingly if you’d like.
What’s Most Important to You?
The downside of seller financing is that you’re taking all the risk. If the buyer defaults, legal action might be your only recourse. The worst part about that is that you didn’t want the business anymore. That’s why you sold it in the first place.
The upside seems worth the risk in most cases. Seller financing opens up your pool of buyers to a much larger crowd; it boosts your chances of not only finding the right buyer (the one you know is right from deep down in your soul), but it also justifies a higher sale price. There are tax benefits to consider as well, since seller financing results in lower annual capital gains tax than an all-cash deal.
In the end, an all-cash offer trumps everything, because there’s nothing to worry about, unless you just don’t feel like that person is the “right” buyer for your business. Is the no-brainer cash more important than using seller financing to someone with a little more risk, but a lot more spark for your business?
Ultimately, the choice is yours. Whether it’s to cash out for as much as possible, or to make sure their baby falls into good hands – seller financing is just another option when trying to find the right buyer for your business.
For more advice on how seller financing works, you can find Getting Acquired on Amazon.
Andrew Gazdecki is a four-time startup founder with three-time exits, former CRO, and founder of MicroAcquire. Gazdecki has been featured in The New York Times, Forbes, Wall Street Journal, Inc. Magazine, and Entrepreneur Magazine, as well as prominent industry blogs such as Mashable, TechCrunch, and VentureBeat. Now, for the first time, Gazdecki shares the complete story of the company that started it all.