Seller financing occurs when the current seller offers a loan to a new buyer to cover a portion of the purchase price. It can be an incentive for the buyer who may not have enough capital to purchase a facility plus the business. It is beneficial to the seller because the seller can often obtain a slightly higher sales price on the business.
Many lenders, both commercial banks and the Small Business Administration (SBA), like to see some seller financing, often between 10-60% of the sales price, because it shows that the seller has an investment in the outcome and is optimistic about the future of the business.
WHAT IS SELLER FINANCING?
Pretty much, its exactly what it sounds like. The seller offers a loan for a portion of the purchase price to the buyer. The seller typically requests collateral and a personal guarantee to secure the loan.
Sellers offering financing customarily operate like a bank and generally check the buyer’s credit report, personal financial statements and background information, such as a resume, prior to extending a loan. If the buyer has a strong credit score, above 680, this will increase the chance of obtaining seller financing.
Sometimes sellers are initially reluctant to offer financing due to the risk of buyer default. Occasionally, however, a seller would prefer to offer financing if they are seeking to obtain a stream of income over a period of years at relatively favorable interest rates. This, combined with the opportunity to sell their business for a slightly higher price, makes seller financing an attractive option for many sellers. Some buyers otherwise might not be able to afford the cost of the business plus several months of working capital required to begin a new facility.
IS SELLER FINANCING PREVALENT?
BizBuySell is the #1 online marketplace for buying and selling businesses. Their recent survey indicated that 60-90% of all businesses offer seller financing. We believe that number is probably lower for senior and adult care facilities.
TYPICAL TERMS FOR SELLER FINANCING
- Usually between 3-7 years duration
- Finance between 10-60% of purchase price of business
- Carry an interest rate at or below bank rates
PERCENTAGE OF PURCHASE PRICE COVERED
While some sellers offer 30-60% of the purchase price, as a practical matter, most sellers limit their exposure to 15-20% of the purchase price. In addition to seller financing, buyers predominantly use cash, bank loans, SBA financing and money from retirement accounts under the Rollover For Business Start Ups (ROBS) program. Money for business start up purposes may be taken from retirement accounts tax and penalty free. ROBS monies allow flexibility because they are the buyer’s own funds and will not be an addition to debt.
Generally, the rates and terms of seller financing are similar to bank financing. Although the seller naturally desires to receive the most money possible, they don’t want to charge such high rates and disadvantageous terms as to make it impossible for the buyer to earn a living wage from the business, while paying seller-financed debt out of cash flow.
SELLER FINANCING AND BANK OR SBA LOANS
- Full or partial standby
When seller financing is used in conjunction with SBA financing or a conventional bank loan, one typical lender requirement is to have the seller in full or partial standby for at least two years. Full standby means that the seller will receive no payments on the seller-financed debt for at least two years in order to provide the buyer with a better opportunity to get the business off the ground prior to commencing repayment of the seller loan. Partial standby means the seller will receive interest payments only during the first two years.
SUBORDINATION TO OTHER LENDERS
Another condition to seller financing is that it is always subordinate to bank or SBA financing. Both banks and the SBA insist on this as a stipulation when they offer financing. The significance of this is that for any forced sale, the bank or SBA debt is satisfied first from the proceeds of the sale. Seller-financed debt is entitled to the remainder. A seller may be reluctant to accept these terms, but they are requisite for bank or SBA financing.
SELLER FINANCING PROTECTIONS
Since seller financing is subordinate debt, most sellers demand certain protections in exchange for offering financing such as:
- Real estate as collateral
- Personal guarantee of buyer
- Control of business
In the case that the buyer defaults, the seller would have some recourse if the buyer hasn’t made payment. It is extremely rare to see a seller regain control of a senior or adult care facility due to buyer inability to repay seller-financed debt, but it is an option that some write into the terms for non-payment of 60 days or more.
The bank or SBA has seniority on the debt for the senior or adult care facility, and in the case of default, the seller would be entitled to only a portion of the proceeds. Usually in the purchase of the senior or adult care business, there is real estate and a business. The real estate is typically used as collateral for the bank or SBA, so it is ideal if another piece of unencumbered real estate is pledged for the seller-financed debt.
Although there are some risks involved with seller financing, it’s sometimes a great incentive to close the deal. A seller should do their best to “vet” the buyer’s financial capabilities prior to the extension of financing in order to minimize the risk of default. The seller should also offer adequate training and orientation to the new buyer so that the care facility has the best chance of thriving. Buyers and sellers stand to gain from seller financing. Buyers benefit because seller financing can provide much-needed capital to make the purchase occur, and sometimes it is an additional incentive to other lenders to offer financing. For the seller, offering seller financing can often attract more prospects and sometimes bring a higher price for the business.
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