Seller financing, aka seller carryback, is a loan the seller of a business gives to the new buyer to cover all, or a portion, of the total purchase price. Seller financing for business carries strong benefits for both buyers and sellers. It can give buyers access to more capital to buy the business, and opens up the pool of potential buyers to a much wider audience for the seller.
If you’re a buyer that’s negotiating seller financing, you should also consider a Rollover for Business Startups (ROBS). A ROBS allows you to use retirement money to fund your business without paying penalties or taxes. To see if a ROBS is right for you, schedule a free consultation with a ROBS professional at Guidant.
What Seller Financing Is
Seller financing happens during the sale of a business when the seller decides to finance a portion of the purchase price. It can be the primary financing source, but more typically is used as a portion of the capital stack to complete the purchase. Seller financing is sometimes also referred to as seller carryback, seller carry, or owner financing.
Sellers who offer financing act a lot like a bank would in the business sale transaction. They can check the credit report of the buyer, ask for a personal financial statement, resume, and other pertinent information, all before making a financing decision. They may also request collateral and a personal guarantee to secure the loan.
To increase the chances of getting seller financing, buyers should make sure they have a strong credit score. A good credit score is 680 or above. Above 725 is considered great. You can check your credit score for free here. Having a score lower than that will hurt your chances, but not totally eliminate them from being approved.
Seller Carryback Popularity
The largest online marketplace for buying and selling businesses, BizBuySell, regularly surveys business brokers about topics like prices and financing. In a recent survey, 74% of brokers, and 58% of owners, reported that they believe seller financing to be either essential or important to closing small business acquisitions in today’s market.
Benefits of Seller Financing
Most sellers are initially reluctant to provide seller financing because of the risk that the buyer won’t pay back the loan, but it can benefit both the buyer and the seller. Seller financing helps the seller attract buyers and get a higher price for the business, and it helps buyers who may not have access to the full purchase price through other means.
Here’s the specific benefits of seller financing for both buyers and sellers:
Owner Financing Benefits for Buyers
- Get Cheaper Financing
- Access to Financing
- Quicker Closing
- Fill Financing Gaps
As a buyer, seller financing can get you access to a large amount of capital that you may not qualify for otherwise, and it is typically cheaper than getting a loan from a lender. If you’re looking to get an SBA loan to make your business purchase, the lender may want to see seller financing involved in the transaction. This gives the lender evidence that the seller believes in the future of the business, and in you as the owner.
Owner Financing Benefits for Sellers
- Attract More Buyers
- Quicker Closing
- Make More Money
- Increased Sales Price
With seller financing, you can attract more buyers and price the business higher because you’re providing financing, which allows the buyer to pay for the business over a period of months or years. Many serious buyers will not even commit to buying a business that doesn’t offer seller financing because if the seller has no skin in the game, the business opportunity doesn’t look as attractive.
Typical Seller Financing Terms
Each seller has a different mindset of what they want to get out of their business, and when they need the cash for the sale of that business. However, there are some commonly accepted terms that can be a good thumb in the air when looking to negotiate seller financing. Terms for seller financing will commonly include:
- Loan Amounts: 30% – 60% of the purchase price (some sellers may do full financing with a substantial (15-20%) down payment)
- Term Length: 5 – 7 years
- Interest Rates: 6% – 10%
- Repayment Schedule: Monthly
Seller Carryback Coverage Amounts
Sellers will typically finance about 30-60% of the purchase price of the business, but every transaction is unique, and some owners may offer more or less financing. For example, if the business is of a type that lenders traditionally won’t provide money to (e.g. insurance businesses), it may be covered by more seller financing.
Seller Carryback Terms
The terms you can get from your seller will be unique, with too many factors to know for sure what you’re likely to see. However, it is common for small businesses to receive terms in the range of 5-7 Years
Seller Carryback Interest Rates
The interest rate of a seller note is typically at or below bank rates. Right now you would be looking at interest rates between 6-10%. The rates of the loan have a lot to do with the specifics of the deal and the buyer’s ability to afford the loan payments.
Buyer Qualifications for Seller Financing
Now let’s take a look at what the industry standard for qualifications with seller financing. Typically there will be personal qualifications and agreement to certain seller protections.
Some sellers won’t check your personal credit before they move forward with seller financing because they are generally willing to take back a note in the sale based on their knowledge of business performance. If they’re comfortable that you can operate the business at least as well as they have, then they know about how much cash you’ll have to pay them. Here’s what they will expect of you personally, though:
Many sellers will want a substantial amount of money paid up front, because they won’t be getting the full payment for their business immediately. You can expect a down payment requirement of 10-25%.
The seller wants to make sure they can collect any damage you’ve done to their business if you end up not being able to make payments. Your personal assets will likely be at risk in this case. They may require you to submit a financial statement to verify your assets. Even when signing a personal guarantee, we don’t recommend pledging specific personal assets for seller financing as it ties your assets up and limits your financial opportunities.
Satisfactory Business Plan
The seller will want to know how you plan on running the business, so they can predict your likelihood of success. A business plan is the best way to show your operations strategy.
The seller may want you, or a CEO you’re bringing on to run the business, to have a substantial amount of industry experience. This lowers the risk to the seller of poor business performance.
If your credit is checked, sellers will want to see that you’re a prime borrower, or close to it. Your credit might be the only indication a seller has of how much a risk it would be to offer you seller financing. If you’re unsure of what your credit score is, you can check it for free.
Seller Protections & Business Requirements
The seller is going to be very comfortable with the business, because they’ve been running it for some period of time. The only qualification for the business moving forward are seller protections put into place to protect their interest. These protections may include:
Control of Business for Non-Payment
A seller’s biggest fear when providing seller financing is the buyer defaulting on the loan. To avoid this from happening, sellers generally want terms that give them the right to take back control of the business within 30 or 60 days of the buyer missing payment.
Sellers will want to file a blanket UCC lien on all business assets to secure their interest in what you owe them. It is common for sellers to take a second position to a bank if you plan on using additional financing. They may also want any business real estate to be used as collateral.
Minimum Inventory Levels
For businesses that operate with a substantial amount of inventory, there are sometimes clauses which require the new business owner to keep inventories at certain levels. In the case where the seller resumes control, they will at least not need to have to make a large expenditure on inventory.
Expenditure & Financing Restrictions
The seller may restrict how much you spend or how much additional financing the business can take on while you still owe them money for the purchase of the business. For example, it is typical for buyers to be restricted to spend more than 1-3% above the seller’s largest expense period while they ran the business.
Paperwork Involved in Seller Financing
Typically, there are several legal agreements that need to be drafted and signed as part of a business acquisition. Here are the main documents, as well links to some free templates (you should have an attorney review and customize all paperwork as necessary for your deal):
- Letter of Interest (a preliminary framework for negotiating the terms of sale)
- Deal Contract (the final terms of the sale of the business)
- Promissory Notes (the loan document for seller financing and other loans)
- Security Agreement (describes what and how the lender can access collateral).
- The new lease for the commercial property (if applicable)
- Transfer documents for any vehicles that may be part of the purchase
- Bill of sale (transfers ownership of tangible business assets)
- Non-compete agreement from the seller (if applicable)
- Bulk sale documents (govern the sale of inventory)
- IRS Form 8594 (shows how assets are allocated during the purchase)
- Consultation/employment agreement (these are necessary if the owner will be staying on as a consultant or employee to aid with the transition of the business)
Using Seller Financing With Additional Financing
Since seller financing often doesn’t cover the entire purchase price, most buyers need some additional financing to buy a business. In the table below we cover the three most popular forms of financing to combine with seller financing when buying a business, and what their general terms & qualifications are.
Additional Forms of Financing to Combine With Seller Financing
If you’re not sure where to start, you can learn more by reading our article on how to get a loan to buy a business.
A rollover for business startup (ROBS) uses your current retirement account to fund your new business, without the early withdrawal fees or tax consequences retirement accounts often carry. A ROBS isn’t a loan, so you don’t have to worry about interest rates or making payments, and it can be used to start a business, buy a business, or recapitalize your business.
When you use a ROBS to fund your business, your retirement account essentially is owning shares of that business. When your business becomes profitable then you return those profits to your tax advantaged retirement account. You can learn more about how it works by reading our ROBS ultimate guide, or by checking out our recommended ROBS providers.
A ROBS is great to combine with seller financing because you don’t have to worry about a bank wanting first position on the business assets (which may give some seller’s pause). A ROBS can also serve as a down payment for other types of financing, or it can bridge the gap between traditional financing and seller financing.
Bank Loans & SBA Loans
Traditional bank loans and SBA loans typically are the financing with the cheapest interest rates and longest terms. They are difficult to qualify for, and can take much longer than all other forms of financing to fund.
In order to get a bank or SBA loan, you generally need to have excellent credit, real collateral like real estate, and a down payment of 10-30% of the loan amount. For the down payment, you will need to bring cash to the table. If the rest of your application is very strong, the lender may consider seller financing as part of the down payment.
Whenever seller financing is used in conjunction with an SBA loan or bank loan, there are usually two rules the lender will require you to follow:
The Seller Must Be on Standby for 2 Years
Standby affects the seller’s ability to receive payment on the loan from the buyer. Full standby means that the seller won’t receive any payment on the loan for 2 years. Partial standby means that the seller will receive interest-only payments for 2 years.
The Seller Must Subordinate to the Lender
This means that if the buyer defaults and the business closes down, the bank gets first dibs on the proceeds from the sale of any collateral.
For more information about getting bank loans, SBA loans, or other financing options to buy a business, read our article about business acquisition funding.
A home equity line of credit, or home equity loan, is a great way to fund the purchase of a business if you have more than 15% equity in your home. A HELOC can get you financing up to 90% of the equity in your home. In exchange, your home is used as collateral for the loan. You’ll need good credit, and plenty of equity to use the funds independently to buy a business.
Using a HELOC with seller financing could be a good option for you if you’re a homeowner with a lot of equity in your home, and don’t want to use a bank. A HELOC can close faster than a bank loan, but the interest you’ll pay will be comparable to an SBA or traditional bank loan. It is one of the best sources of startup funding available to brand new entities.
Pros & Cons of Seller Financing
Seller financing is a good option that is often used through many business purchase transactions every day. It has many pros and cons that are important to understand, regardless of whether you’re the buyer or seller, before you get started.
Pros & Cons of a Seller Carry for Buyers
- Affordable Monthly Payments: Seller financing is often cheaper than other financing, and requires a single monthly payment to the seller.
- Access to Additional Capital: Seller financing could get you access to additional capital, or it could fill a gap of financing you don’t currently have access to in order to.
- Quicker to Close: Using seller financing is faster than many other forms of financing that it could replace.
- Sellers Have a Vested Interest: Since the sellers have a vested interest in the success of the business, it could provide you with a go-to resource to get advice or guidance from in the near future.
- Seller Involved Post Closing: If relationships are an important part of your new business, then it may be more difficult for the seller to separate from the company if he/she has an interest in it.
- Could Lose the Business if You Don’t Pay: Sellers who finance the purchase of your business may be quicker to take over the business if you start to miss payments. A bank would have to sell it or liquidate it, which takes time and could diminish its value. A seller can easily take it back over and start operating immediately.
Pros & Cons of a Seller Carry for Sellers
- Increased Purchase Price: If you offer seller financing than you can typically get your full purchase price, or possibly a little extra money for the business than you would otherwise.
- Quicker Sale: Offering seller financing can increase the speed of closing, which is almost always a good thing for the seller.
- More Potential Buyers: Being upfront about offering seller financing could increase the amount of potential buyers you may have to sell the business to.
- Tax Advantages: You only have to pay taxes on the payments received, so your initial income taxes will be less than if you were paying on the total sale amount.
“The biggest advantage to the seller is the tax treatment. It’s possible for a seller to slow down the recognition of gain by reporting the sale in installments. This spreads the capital gain out over the period of the sale. The seller also gets the additional benefit of income from interest over that period.”
— Cameron Kelly, Attorney at Stillwater Estate Planning
- Increased Risk: If the buyer defaults then you could end up getting a business back that has a lower value than it did when you sold it. Many businesses have important relationships that could be damaged or changed if the business starts to struggle. This could lower the amount of money a seller ends up getting.
- Maintain Vested Interest in Business: Using seller financing means you’ll retain an interest in the success of the business. If you’re wanting to make a clean break, then this may not be the best option for you.
- Less Immediate Capital: You’ll be getting the majority of your payment for the business at a later date, so there is less money now to reinvest elsewhere.
Seller Carryback Tips for Buyers
If you’re a buyer thinking about seller financing for your business purchase, then keep the following tips in mind before you start the process in order to maximize your success.
Ask Early On in the Sale Process
As a buyer you should be up front about your desire to have the seller carry back a note. The earlier you bring it up, the quicker you’ll know if it’s a possibility. You don’t want to surprise the seller late in the sale process that you need them to give seller financing, because they may lose faith in your ability to close the transaction.
Get Professional Help
Often when you buy a business, a business broker is involved. However, buyers should remember that the business broker works on behalf of the seller, and the seller generally pays the broker fees.
In addition to the broker, buyers and sellers often involve their lawyers, accountants, and appraisers to value the transaction and go through the financials and paperwork. For more on how to value a business, read our in-depth article.
Use Seller Financing as Secondary Financing
“A dollar today is worth more than a dollar tomorrow to the seller. The most optimal solution would be to have a buyer use a bank or business lender to finance as much of the purchase price as possible.
— Chris Balestrino, Managing Partner at Madison One Capital
The seller can then provide a small, subordinate loan to complete the capital stack. This is especially enticing to buyers because it will prove that the seller has something to lose if the deal goes south post closing. More importantly, the seller is able to maximize the value of their business and assets without financing too much of the risk.” –
Some Sellers are More Open to Seller Financing
Many sellers are looking for a clean break from their business, and so seller financing will not be a good fit for them. Others are more open to the monetary benefits of taking back a note for their business, and are just more open to it. You should be clear with your seller what your expectations are so that they can communicate to you what their desire is.
Seller Carryback Tips for Sellers
Sellers looking to offer financing should keep the following tips in mind so that it’s done properly.
Do the Math
Figure out the numbers before you offer seller financing to know that you can afford to do so, and at what terms you’re able to offer it. This will help you be decisive during negotiations so that you get the best deal for yourself. You will also know what your cutoff point is for both purchase price and interest rates before the buyer tries to negotiate.
You also want to know what your business is worth before you negotiate seller financing, so you can get the true value out of it. To learn more you can read our article on how to value a business or use our business valuation calculator.
Do Your Homework
Make sure you check your buyer’s credit before you approve them for financing. Treat the transaction the same way a bank would in terms of researching a potential borrower. Have the buyer submit a business plan to get you comfortable with their operational strategy moving forward. You’ll know better than anyone whether they’re likely to be successful or not.
Get Legal Help
Find an attorney that you’re comfortable with who can help guide you through the process. Offering financing is likely not your business specialty, and you may be missing something if you try to do it all on your own. Legal help is necessary to make sure you’re fully protected from any potential risk you may not be aware of.
Get a Personal Guaranty From the Buyer
“The buyer(s) may be financially unable to perform or simply choose not to perform the terms of the deal. For that reason, sellers of businesses with seller financing should seek a personal guaranty from the buyer(s) and do their diligence as to the guarantor(s) finances.
For example, receive a sworn personal financial statement from the guarantor(s) and proof of ownership of the assets shown on the personal financial statement.
Another option for sellers is to receive a perfected security interest in the assets, corporate stock or LLC membership interests sold. Whichever form the security takes, the seller should always receive a note payable from the buyer(s) as evidence of the indebtedness.”
— Brian Thompson, Attorney and CPA at Brian Thompson Law
Get a Down Payment at Closing
Just like a bank loan, you should require a down payment at closing. Make sure you collect enough money up front to make it worth it for you immediately, and enough for you to know that the buyer is fully invested in the business. Offering 100% financing is like giving your business away with the promise of monthly payments in the future. You could end up with very little if the deal goes south.
Bottom Line: Seller Financing
Seller financing for business can be a good option to either use to buy a business by itself, or as a smaller piece of the total capital stack. It is commonly used to sell small businesses, and can be beneficial to buyers needing extra financing and sellers looking to close quickly. We recommend using seller financing as an additional piece of financing on top of something else, like a ROBS.
A Rollover for Business Startups (ROBS) is a good option to finance the purchase of a business if you have at least $50K in a 401k, IRA, or other eligible retirement account. With a ROBS you can get access to your retirement funds without paying fees or taxes. Our recommended ROBS provider is Guidant. Visit them today to start the process of setting up your ROBS.