How to Acquire a Business with Seller Financing - How to Buy a Business with Seller Financing & how 5 M&A Experts use it

A seller's note is commonly known as seller paper and seller debt, is a form of financing used in small company sale transactions whereby a seller agrees to receive a portion of the acquisition proceeds in a series of debt payments.

A seller’s note is commonly used to bridge a gap between the amount a seller is seeking in a sale transaction and the amount a buyer is willing or able to pay.

Seller Note Facts:

A Seller’s Note is unsecured - which means it is not collateralized.

In a typical acquisition including Senior Debt (example: SBA loan), seller notes, the Senior Debt has the highest priority for payment, followed by seller notes.

As a result, there is more risk to a seller note than Senior Debt.

To offset this risk, seller notes often pay a higher rate than Senior Debt.

A typical seller note will mature over a similar period and carry an interest rate of 6-10%.

Benefits to the Seller:

Typically, a seller note allows for more flexibility in the acquisition and increases the probability of closing the transaction at a value acceptable to the seller.

Receiving interest over the life of the loan will increase the total value received, and the interest is often much higher than a seller can receive from cash sitting in a bank account. Cash can only earn at most 1%, if it sits in a bank, while a note can earn 6-10%.

The seller knows the business well and can have confidence they will be repaid.

The seller note offers tax advantages to seller

Risks to the Seller:

Most seller notes are unsecured. This means if the business were to fail, and the seller note defaults, there may not be any collateral to cover the seller note.

New owner may make bad decisions The future performance of the business is unknown, and, like any lender, this presents a risk that the seller note may not be repaid.

Seller notes are subordinated to Senior Debt. If the business is not producing enough free cash to cover all of its obligations, including the seller note, the seller note may be impaired.

It may not make sense to seller. Why would the seller finance a purchase for the buyer and assume MORE risk? The higher the seller financing number the higher the seller is assuming all the downside risk without any of the upside of ownership – many will say no thank you.

Benefits of Seller Financing to Buyers

Seller is vested in the business’ success - Since the seller remains vested until the seller note is paid in full, it is a sign that the seller has confidence in the future of the business. They also remain a go-to resource for guidance or advice when you need it.

Less cash at closing bridge the price gap - The seller note can bridge the gap when you do not have sufficient funds to buy a business. If you can only qualify for a bank loan that’s 60% of the purchase price as well as equity that’s 10%, you may have seller financing for the remaining 30%.

Affordable payments - You make a single payment to the seller each month.

Quicker process - The transaction can be concluded more quickly at a price that is acceptable to the seller.

Benefits to the Buyers

Increased flexibility - Increased flexibility in loan terms when compared to a bank loan.

Mitigate against challenging business circumstances and market environment - Sellers may arrange a seller note especially if the business has significant challenges. These challenges include irregular revenue patterns, cyclical nature, high capital intensity, growth capital needs, customer concentration and small size.

SBA loan capital contribution - SBA loans may allow the inclusion of the seller note when calculating your capital contribution to the transaction.

Risks to Buyer

Its unsecured so you may have to offer a Personal Guarantee.

You may screw up the payments and seller sues to force payments

The interest on a seller note may or may not be paid on a current basis through the maturity date. Instead, the interest may be deferred or accrued until the maturity date.

Negotiate the right mix of seller financing, usually, 20-30%

Be transparent on default resolutions

Don’t forget about Debt Service Coverage Ratio

Keep Seller Financing Notes to a short term to mitigate risk to seller.