Should you finance a buyer who is purchasing your
business?
On the downside, if you allow
the buyer to pay you off slowly over time, you'll retain
many of the risks that come from continued ownership of
the business while giving up control of its management.
In most cases, the buyer's ability to make the payments
will depend on the future success of the business, yet
your buyer may know little about your company, your
customers, or even your industry. The buyer can
mismanage your company down to nothing very quickly, if
you don't keep an eye on him. If the buyer runs aground
and stops making payments, your only real recourse may
be to foreclose on the note and repossess the business,
but that means you'll have to find another buyer and
start all over again.
On the upside, carrying back a
note for some or all of the purchase price may be the
only way to sell the business, since banks have fairly
strict lending criteria for acquisition loans. Moreover,
seller financing can provide a tax break for you if you
qualify for installment sale treatment. For the buyer,
seller financing can be a godsend because you'll
generally have more relaxed qualification standards and
more lenient terms than a bank would have.
Mechanics of seller financing.
The simplest way to provide seller financing is to have
the buyer make a down payment (generally, you should
insist on a down payment that's as large as possible),
with you carrying back a note or mortgage for the rest
of the purchase price. The business itself, and/or the
significant business assets, provides the primary
collateral for the note. A lien on the property is filed
with the secretary of state's office, so the world at
large knows that it exists. If the buyer defaults on the
note, you'll be the first in line to step back in and
take over the business.
Aside from its simplicity, this type
of deal can be very flexible you can adjust the
payment schedule, interest rate, loan period, or any
other terms to reflect your needs and the buyer's
financial situation. For example, you can provide for a
floating interest rate, or one that starts low but goes
up gradually over time. Most seller financing will be
for a relatively short term (say, five to seven years)
but will be amortized over a much longer payment
schedule, so that at the end of the loan term there's
still a large portion of principal remaining. The buyer
will have to obtain outside financing to pay off the
balance of the loan in a "balloon" payment at the end of
the loan period. The idea is that at that point, the
business will be on a solid footing and bank financing
will be easier to find.
The buyer may have lined up a bank to
do the primary financing on the deal, and may want you
to take back subordinated debt for the remainder of the
price, in a variation of a leveraged buy out (LBO). In
that case, you are second in line if the buyer defaults
on the primary loan. Obviously, this is not as desirable
a position for you, and if you agree to it you should
demand a higher interest rate. You should also think
about continuing to maintain an equity position in the
company, so that you have a voice (even if not the
controlling voice) in the management of the company.
Protecting your interests.
If you agree to finance part of the deal, you should try
to get the buyer to provide more security for the loan,
besides the business itself. For example, you might
require the buyer to put up a personal residence as
additional collateral (assuming there is significant
equity in the home.) Some buyers have other commercial
real estate, or investments that can provide more
security. You can also require the seller to personally
guarantee the loan, just as a commercial lender would.
This can protect you if, as is often the case, the buyer
finds that running the business is harder than it looks
and is tempted to welsh on the deal. And, of course,
you'll want to thoroughly check out the buyer's
background, including credit record, management
experience, personal assets, and character, just as the
buyer will check you out during the due diligence phase
of negotiations.
In order to further protect yourself,
you should require the buyer to take out a life
insurance policy with yourself as beneficiary, so that
the loan will be paid off if the buyer meets an untimely
demise. If the buyer will be actively working in the
business, you might also consider getting disability
insurance on the buyer, although sometimes this is
prohibitively expensive. Your sales contract may also
restrict the new owner's sale of assets, acquisitions,
and expansions until the note is paid off, and may
specify that you get to see the quarterly financial
statements so you can keep tabs on the business.
Instead of financing per se,
particularly if you're being asked to put up secondary
financing to a bank's acquisition loan, you might be
able to have the buyer purchase an annuity contract for
you, or purchase some zero-coupon bonds. These are sold
at a deep discount off of their future value. With this
approach, the buyer gets the benefit of a lower payment
now, but you won't be so dependent on his or her future
success. This plan works best in the situation where you
suspect that you have a well-qualified buyer who could
actually pay cash for the business, but simply doesn't
want to tie up all his funds there.
