Seller Financing

When I meet with a client for the first time, I always ask if they've considered providing part of the financing for the sale of their business. The answers are either "I'd rather not", or "Do you think I need to do that?"

Here are the options:
1) Cash buyer
2) Down payment with SBA financing
3) Down payment with seller financing

1) Cash buyers are the preference. Here is the stumbling block. As far as a buyer's expectation, they typically want to use their cash for leverage. If someone has $150,000 for a down payment, here are some of their options:
a) Buy a business for all cash. Positive is that there is no debt service. They are probably buying a business netting $80,000-$100,000 a year.
b) Buy a $500,000 business, with $100,000 down, and $400,000 financed through SBA, or combination of SBA and owner financing. They SBA will typically require a 20% down payment, so the buyer can get leverage on their money. They can probably get a net income before debt service of between $200,000 and $300,000. So, after debt service, they are likely netting more than the $80,000 - $100,000 they could net if they paid all cash.

So, although the preference of the seller is to find a cash buyer, the buyer is better off leveraging their capital and simply making more money. Also, a general rule of thumb is that a buyer expects to be able to earn whatever amount they are using as their down payment. Again, rule of thumb.

2) SBA financing. In order for the business to qualify for SBA, you need at least these 4 circumstances to be met.
a) The business needs the past 3 years of tax returns (you'll be shocked at how often the seller won't provide tax returns)
b) The tax returns need to show enough profit that it covers debt service by at least 1.25-1.35 times (the bank wants a 25-35% cash flow cushion above the debt service amount).
c) The tax returns, after showing 1.25-1.35 times debt service coverage, needs to provide a livable wage for the buyer. The SBA will have them fill out a form that lists all of their expenses, and they have to be able to earn a certain percentage above having all of their expenses paid.
And, if that isn't tough enough...
d) The buyer needs industry experience, or experience transferable to the business.

So, it isn't that bank or SBA money isn't out there, it's difficult for a business to qualify.

3) And that's why the seller typically needs to provide some sort of financing for the buyer's purchase. They'll get a personal guarantee from the buyer, we will receive a copy of the buyer's credit report, proof of funds in the bank and investment accounts, a note evidencing the debt, and a lien on all equipment of the business.