Of course, most sellers won’t finance 90 percent of their asking price. But borrowing 10, 20 or even 30 percent from a seller at a competitive rate still beats using your credit card to cover capital shortfalls. If you’re interested in seller financing, here’s what you need to know.
Being short on cash isn’t the only reason to push for seller financing. These loans can also bridge the gap if you and the owner can’t agree on a price.
Renzo Aida, who bought a dance studio near Boston in 2013, will attest to that. He had the money to pay the six-figure asking price in full, but he thought the seller wanted 20 percent too much.
“I wanted him to put his money where his mouth was,” Aida says. Both parties went into negotiations and eventually got what they wanted. Aida has since increased revenue by 28 percent.
Besides cashing out, sellers want assurances their baby will be in good hands. They want a buyer who has experience in the industry, a solid business plan, working capital and roots in the community, says William White, regional developer of Murphy Business & Financial Corporation, a national business brokerage firm. Sellers treat these loans as seriously as any bank would, says White, who lives in Hudson, Ohio. This means requiring a credit check, collateral (business assets and possibly your home) and life insurance. Loan terms often extend up to 10 years, interest rates are comparable with those offered by banks and it’s typical for sellers to stick around for 60 to 90 days post-sale to advise the buyers.
It’s not enough to grill the owner on the intricacies of their business. You have to scour the financials, from bank statements and cash flow to tax returns and profit-and-loss (P&L) reports. You also have to inspect the physical property to ensure all inventory, equipment and other assets are accounted for and in working order. “Otherwise, you don’t know what you’re getting,” Regotti warns.
Owners may not openly advertise their willingness to partially finance a sale -- but, according to White, it’s common for them to consider lending at least 5 to 15 percent of the purchase price.
KC Truby of Tucson, Arizona, who has bought six owner-financed businesses over the past five decades, suggests agreeing to the asking price but getting creative on the terms. Regotti, for example, nabbed 90 percent seller financing by promising to apply for an SBA loan two years down the line. If she gets it, she’ll pay off the seller in full. Other buyers can bridge valuation disagreements with an earn-out clause that grants the seller extra pay during a set period if profits meet or surpass expectations.
The rest, he imagined, he’d borrow. But when Short applied for an SBA loan, he was told the government body required at least 10 percent of the deal to be financed by the seller. Although Short hadn’t considered taking a loan from the seller, he was happy to comply if the terms were right.
Short wound up making a 40 percent down payment on FiberTech, borrowing an additional 50 percent through an SBA loan, and borrowing the remaining 10 percent from the seller. “It helped me to not have to put in that additional 10 percent,” Short says. With the extra cash, he was able to boost the company’s marketing efforts, invest in vehicles and equipment and ramp up staff from 14 people to 20. Since purchasing FiberTech in March 2011, Short has seen revenue increase by about 20 percent.