What is Seller Financing?
Updated: May 17, 2020
If you are selling your business, the buyer might ask you to finance part of the purchase price. This is customary in main street deals (see this post for a definition https://www.joelankney.com/blog/what-is-a-main-street-deal).
Seller financing is a loan from you to the buyer for part of the purchase price. You don't actually give the buyer cash; you allow it to pay a portion of the purchase price over time after the closing.
Seller financing means the buyer delivers a promissory note to you for the difference between the purchase price and the amount of cash the buyer pays you at closing. For example, if the purchase price is $1,000,000 and the buyer pays you $750,000 in cash at closing, the buyer also will deliver to you a promissory note at closing for the remaining $250,000, plus interest. That promissory note evidences a loan that is the seller financing.
A buyer may want (or need) to do seller financing because (a) it can't get a commercial loan from a bank, or (b) it doesn't like the bank's terms for the loan (e.g., the interest rate). This means you become the "bank" for the buyer. You become a creditor.
There are some risks with seller financing. The buyer might not be creditworthy. If the buyer stops paying the promissory note after closing, you will need to sue the buyer to collect the note. Or, if the buyer files for bankruptcy after closing, you will get sucked into the bankruptcy process. Collecting on the note will cost a lot (attorney's fees) and take a lot of time. It will be stressful. And you may not collect most of what you are owed.
So, why would a seller do this? Because you might not be able to sell the business if you don't. It makes the business deal more attractive if the buyer is able to get its financing through you, rather than a commercial lender. And the buyer might not be able to do the deal if you won't finance some of it.
You need to act like a bank if the buyer asks for seller financing. You need to investigate the buyer's credit strength. You need to consider the ratio of the debt to the cash you are getting paid at closing. You need to have the proper legal documents in place (at least a promissory note). Your legal documents should indicate that the buyer will pay your attorney's fees and costs if you have to collect. You need to negotiate reasonable terms for the loan, like the interest rate, the payment frequency, and the length of the payment period. You need to get some collateral so that you are a secured creditor and can foreclose on the loan, if the buyer defaults. You need to stay on top of the buyer after the closing.
Don't shy away from seller financing, just be careful.