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Seller financing: what is it? How does it work?

Seller financing is a commonly used, useful substitute for bank finance.

What exactly is seller financing?

A loan given by the seller of a business to its buyer, usually on similar terms to a bank loan. 

As with a conventional bank loan, the seller will usually make a down payment and pay up the remainder in monthly instalments over a pre-agreed time period.

The terms of the deal are set out in a legally binding purchase agreement that is created with the help of a solicitor and signed by both parties.

What if the buyer defaults?

Again, it's similar to a bank loan, insofar as the business is repossessed or foreclosed.

Doesn't that mean the seller is at risk of not getting all of his or her money?

Yes. Just like a bank, the seller is shouldering the risk. If the buyer mismanages the business it could be hard work restoring the business to its previous value when you repossess the property, while you then have to go through the process of finding a buyer all over again.

The extra risk means the seller can usually set a higher interest rate than a bank ordinarily would.

It still seems like quite a big risk if you are selling your business…

Well if the business has an unimpressive track record or operates in an ultra-competitive sector, then seller financing could improve the chances of closing a deal significantly. That a seller is willing to gamble a huge portion of the sale price on the business's future performance should reassure the buyer, who will therefore often pay a higher price, that the business is sound.

That a seller is willing to gamble a huge portion of the sale price on the business's future performance should reassure the buyer, who will therefore often pay a higher price, that the business is sound

So long as you have confidence in the buyer's experience, attributes and attitude, as well as faith in your business, then you can be confident of getting your money. 

Since the 2007 credit crunch, with banks still highly risk-averse, seller financing is arguably more important than ever to the buying and selling of businesses.

Any drawbacks for the seller?

Well you need to wait for much of your money of course. If you need access to most or all of the asking price immediately - to fund another business acquisition for example - then seller financing won't be suitable, unless used in conjunction with other forms of finance or a large down payment.

And with seller financing you'll have a less complete picture of the purchaser's creditworthiness and employment history, thereby further heightening the risk. 

By contrast, if the deal is financed with bank credit then the seller gets his or her money straightaway and does not shoulder the risk in the event of a default.

How can sellers minimise the risk?

By making sure the buyer is the right person to run their business successfully. Many sellers care about the fortunes of their business after the sale because of their emotional investment in the business, but if you've financed the sale of your business partly from your own pocket then you have an ongoing financial investment too.

To reduce the risk of a default be sure to sell only to a buyer you believe has the right attitude, experience and attributes to take the business forward. 

Are there any benefits for buyers?

As mentioned above, if the vendor offers to part-finance the deal then it suggests to the buyer that they're sincere when they expound the business's merits - and who knows more about the business than the present owner?

A buyer will often be more flexible with repayment terms than a bank, while both parties will make considerable savings in closing costs.

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Adam Bannister

About the author

Adam Bannister writes for all titles in the Dynamis stable including, and as well as other industry publications.


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