Equity Protection in a seller financed deal
What protection is there for the buyer’s equity (25% down) in a seller financed deal? If the buyer is unsuccessful at the business and cannot make the payments and the seller forecloses on the business, will the buyer get any of their equity back?
Thank you for asking Roy.
Seller financing can certainly have many advantages for the buyer, however typically in the event of default the equity of the buyer is not protected.
However, there are no absolutes in a seller financing deal and the buyer may be able to negotiate something with the seller to protect them in the event of default, at least to a degree.
Keep in mind that we are not attorneys and that you should get legal advice when entering into any major business transaction, especially one with added complexity.
I can second Dennis’ reply. Much as would be the case with a real estate transaction, the buyer’s equity is unprotected if the property loses value or is destroyed.
But, if I’m reading between the lines correctly, Roy is looking for a way to hedge against a business failure. A couple of thoughts.
First, the best way to prevent a failure and to screen for any seller misrepresentations is to conduct very thorough due diligence of the business. First and foremost, study the seller’s business tax returns (at least the last 2 years) and ask for the most recent P&L. Were there any drops in revenues or profit, and, if so, why? Ask for a customer list; again, find out if the # of customers is steady, increasing, or dropping.
Second, there may be a way to negotiate and adjustment to the repayment of the Note if the business doesn’t perform as expected. For example, the buyer would be allowed to reduce the monthly payment by a certain amount if the business’ revenues dropped significantly during the first year. However, I’ve found in most cases sellers are acting in good faith (they’re not selling a lemon) and may not be open to any performance-based future adjustment.