Investing in a business can be worthwhile, but only if you have the finances available to invest.
Unfortunately, it isn’t always easy to arrange the financing you need for a business purchase. Considering alternative lending solutions, such as seller financing loans, could solve the problem.
But what is seller financing exactly? Is it a strategy worth pursuing, and is it worth the risk?
To help you decide, let’s look over the pros and cons of seller loans, explain what they are and whether they’re suitable for you.
What Is Seller Financing?
The traditional method of purchasing a business is quite simple. The buyer makes an offer to buy the business from the seller or their agent. The proposal is made using funds that they already have, or by using funds that they gain through a business loan or other line of credit.
This is all assuming that they have the funds to do it or that the buyer has access to credit in the first place. Seller financing offers an alternative, where the seller provides the buyer with the funds instead.
In this scenario, the seller lends the buyer the cash they require. Both parties agree to an interest rate and repayment schedule that takes into account the potential risk on both sides. This kind of alternative lending doesn’t last as long as a traditional loan – it’s usually for a defined period of a few years, with a potential final ‘balloon payment’ at the end.
If you want to learn more, then head to our definitive guide to seller financing to gain a better understanding.
Combining Seller Financing with Other Types of Lending
If you have other lines of business credit available to you, but not enough for your business purchase, owner finance loans can cover the gap.
There are a few types of business loans that work particularly well with seller financing. Are you a recipient of an SBA loan, or can you obtain a business bank loan for a smaller amount?
If so, you can combine these with any seller finance agreement you make with the other party. These are usually subject to specific rules regarding how payments are made, with the bank lender taking priority.
Alternatively, you could use your retirement savings using ROBS or ‘rollover for business startups’. These allow you to invest your 401(k) or other retirement savings into a business purchase without penalty.
Who Are These Deals Suitable For?
These deals are beneficial for business buyers who are unable to find traditional credit for the full value of the business they’re looking to buy.
Owner financing agreements might involve a combination of traditional business loan products with the lending their seller provides. The seller can offset the risk by the fact that they still have some or most rights to the business and can charge a higher interest rate.
If you’re a business buyer who has unusual financial circumstances, you may find that owner financed loans like these are the only way you can achieve ownership of the business you want.
That is, of course, if the seller agrees to lend you the cash.
Advantages and Disadvantages
Before you approach a seller with a seller loan request like this, you should consider the advantages and disadvantages first.
If the seller is the finance lender, you’re reducing the number of involved parties in the transaction. This means that you may be able to get the sale agreed and closed much quicker than might otherwise be possible.
While a seller who lends will want to do their due diligence before lending the cash, they won’t need to go through as long a process, with various other parties, before they can decide whether to loan the funds or not.
The buyer won’t need to pay any fees a traditional lender might charge, assuming the seller agrees to the terms.
Of course, there are disadvantages to this kind of lending.
We’ve already mentioned that, due to the increased risk for sellers, they may charge a higher rate of interest than a bank or loan company. Buyers will have to consider whether the interest rate is affordable for them or not.
Buyers also have to be aware that a seller is going to want to do a background investigation from his/her side if they consider such a financing proposal. If you can’t get traditional credit and don’t have a good reason, why should a seller risk their own money?
You also need to be wary of any terms that might exist in any finance the seller currently has attached to the business. Existing agreements the seller may have may restrict financing from sellers being passed to buyers, which could put the company at risk.
Want to learn more? Then check out some other seller financing advantages and disadvantages from this helpful guide.
How to Proceed
To proceed with an owner financing agreement like this, the buyer should approach the seller with a proposal. If the business is advertised for sale, some sellers may make it clear themselves that they’re willing to entertain such agreements.
If that’s the case, sellers can take a lot of the headache from negotiation away by making clear their terms from the outset. For buyers, if they’re making the initial approach, don’t be vague with the offer.
Scope out the seller’s willingness to consider an agreement first, then make a specific offer. This will include your seller financing request and any other terms to see whether they accept.
After that, it’s up to the buyer to convince the seller that they’re worthy of lending to. Offer up your financial records, and give a clear idea as to why you’re unable to get traditional credit.
At this stage, consult with your legal and financial teams. They can help draw up the relevant legal documents and make adequate financial background checks.
Help make a deal work between yourself and the other party by following these 5 steps to seller financing success.
Consider Seller Financing Carefully
If you’re struggling to get the business credit you need, or you can’t move your business on, then a seller loan could be a good compromise.
Approach the other party to discuss the issue. If they ask you, ‘what is seller financing,’ be sure to pass on our article!
Just be aware of the pitfalls for both parties. Interest rates on financing like this are going to be higher, and you’ll have to pay any money back much sooner, so it might not be ideal for either a buyer or a seller, depending on your financial positions.
For more business ideas and strategies, check out our other business articles and don’t forget to subscribe to our newsletter below for resources you can implement today.