Some seller financing is part of nearly all business transactions. Sometimes it is very minimal exposure such as accounts receivable or assuming a liability of accounts payable. Other times it includes a note with installment payments from the buyer.
On businesses sold below $5,000,000 purchase price, there will normally be some financing by the seller. There will be exceptions to the seller financing rule, however, understand most deals require it. The possibility of the business owner not receiving all of his/her money always exists when there is seller financing. This risk cannot be completely eliminated. The risk can be minimized by guarantees and collateral to support the loan.
Seller financing interest rates are subject to negotiation between seller and buyer. They normally vary between 5% to 12%. Economic conditions will always effect seller finance rates. A major benefit to many seller financed note structures is their option to report the transaction for Federal Income Tax purposes on the installment method of accounting which recognizes profit when the cash is actually collected. Emphasize the importance of seller financing when considering tax strategies.
The seller who wants the first lien position must be willing to finance the entire difference between the cash down payment and the purchase price. The first lien position will not insure full payment but it does insure the seller’s right to foreclose on the business. The lien must be filed with the State at the time of closing to insure the seller is in first position. A UCC-1 Financing Statement and a security agreement must be prepared and signed by both the seller and buyer and subsequently filed with the State. Simply getting the documents signed is not sufficient seller financing protocol.
Typically, the funds to cover the purchase price come from a combination of cash down payment made from the buyer’s own funds, seller financing, and commercial financing. The seller’s note from the buyer will be subordinate to the buyer’s loans from a bank or commercial lender. The bank will be paid in full before the seller will receive any funds from the sale of the assets of the business in the event of a default or foreclosure. There is a risk the seller will not receive all that is due from the buyer. Once a business owner understands that their business will not likely be salable without some level of seller financing, their reluctance to provide some level of seller financing is minimized.