Seller financing, oftentimes called owner financing, is when the current owner of a business provides a loan to the buyer to cover a portion of the purchase price. The terms are negotiable, but are usually amortized over a seven to ten year period with a three to five year balloon payment. The interest rates change just like they do in the market, but are usually around the prime rate plus 300 basis points, which as of today (5/9/16) would be 6.5%.
Why is Seller Financing so Common?
The simple truth to why seller financing is so common with main street businesses is that most banks simply do not loan money for business acquisitions. The reason they don’t is that they prefer hard assets as collateral versus soft assets such as goodwill. When a buyer purchases a business the main asset they are buying is the company’s goodwill.
The largest online marketplace for buying and selling businesses, BizBuySell, regularly surveys business brokers about topics like prices and financing. In a survey last year, brokers reported that 65 to 90 percent of businesses for sale included seller financing. Here along the Gulf Coast nearly 83 percent of our deals include some form of owner financing. This can be as high as financing 80 percent of the purchase price or as low as 10 percent. This shows just how significant of a role seller financing plays in main street business acquisitions.
What are the Benefits of Seller Financing?
Most sellers initially prefer not to provide financing, but soon realize its many benefits. Seller financing helps to increase the pool of potential buyers and to attain a higher price for the business. Most buyers don’t have enough cash to cover the full purchase price of the business, plus initial working capital, plus normal everyday expenses. Therefore, without seller financing you significantly restrict the pool of potential buyers which will usually cause it to take longer to sell the business.
Seller financing can also be beneficial for tax purposes. It allows the owner to spread their income out over a period of time versus all at once, which oftentimes reduces the seller’s tax burden. Each business is different so please consult a professional Tax Advisor.
Lastly, seller financing provides additional income above the normal market rates. As mentioned above, the average interest rate on a seller financing deal is 300 basis points above the prime rate. The prime rate is the rate most banks charge to their favorable customers. With the current prime rate being 3.5% an owner offering seller financing would currently be charging nearly double the interest rate a bank would to a customer with a good credit history.