How to Use Seller Financing to Buy a Business: A Guide
Here’s What We Are Covering:
Advantages of buying a business.
What to look for when buying a business.
Using seller financing to buy a business
Learn the 5 steps to seller financing.
Benefits to seller financing.
Finding a business to buy.
You may have an entrepreneurial spirit and dream to own your own business. Now for the next step: how to turn that vision into reality?
You may begin to research different options. A startup involves a substantial initial investment of time, energy, and resources. It could be a while before you see any return on investment.
Another avenue is to buy an already established business. Finding a business will involve some legwork and talking to people in the industry, but the business has proven its viability in the market.
When it comes to acquiring a business, you have some additional financial options. Unlike a startup, which would rely on your own investment, investments from others, or traditional financing, you have another option of seller financing to buy a business that already exists.
Advantages of Buying a Business
There are some obvious advantages to buying a business, such as acquiring an existing customer base. This could otherwise take you years to establish.
With an existing business, you will know the profits of the company. You may even be able to take regular draws or salary, which would be far less likely in a startup.
You would also be acquiring an existing operation. The business may have employees that would be retained after the acquisition and be a valuable asset going forward. This is much simpler than building the operation from scratch with a startup.
What to Look for When Buying a Business
Your steps in buying a business will usually involve three phases: search, negotiation, and closing the transaction.
As you begin your search, you will want to ask yourself the following questions about any business that you would consider buying:
Why is the business for sale?
What is the reputation of the business?
What are the profits of the business?
Do you think you can increase profitability?
The process of buying a business can be complex. You should use a business attorney to review the deal structure and an accountant to review the bank transactions, financial statements, and tax returns.
You should inspect the assets, such as any offices, storefronts, or equipment. Note the condition and cleanliness of these, as they reflect on the owner's care. You will also want to review any liabilities that the business has, including pending judgments or lawsuits that may not appear on financial records.
Once the deal's negotiations have been completed, you can move to the final phase and close the transaction. This is where funding will come into play.
Using Seller Financing to Buy a Business
When you use seller financing, the seller is essentially acting as the lender. A majority of small to mid-sized business acquisitions involve some kind of seller financing.
For the buyer, this can help achieve business ownership if there is not enough cash to buy the business otherwise. It removes bankers from the transaction and allows the seller and buyer to work together to finalize the deal.
The seller will carry the promissory note, and the buyer makes payments to the seller. This can range anywhere from 30-60% of the purchase price.
The terms of the loan are typically something like 5-7 years. Usually, collateral will be required, such as a mortgage on commercial real estate, along with a personal guarantee.
Seller financing shows that the seller has confidence in the profitability and performance of the business.
Steps to Seller Financing
Since the seller is acting as the financier of the transaction, there are some steps involved that are similar to what a bank loan would require.
The buyer will submit an application, including relevant personal financial information.
The buyer will prepare a business plan, as well as provide background and experience.
The seller will pull a credit report on the buyer.
The buyer may need additional funding, such as a traditional loan or investment from friends or family if there is still a gap between seller financing and purchase price.
The transaction is closed, with a lawyer or business broker drawing up the agreement.
When the seller is providing financing, the seller will want to determine the buyer's creditworthiness to ensure that the loan will be repaid.
Benefits to Seller Financing
In some ways, seller financing may benefit you even more than a traditional bank loan. You have likely already developed a relationship with the seller throughout the acquisition, and the financing is one more way to continue to work together.
A seller may be more flexible than the stringent requirements of a bank. And, unlike a bank, you have the ability to negotiate the terms of the financing with the seller.
Bank financing will typically involve a lot of fees. For example, you may have documentation fees or origination fees. Seller financing will have fewer fees.
Most importantly, you have the vested interest of the seller. The seller will want to ensure that the business continues its success, so the loan is repaid. The seller may continue to advise or consult with you as you take over the business, which can help with the transition both in the short- and long term.
Finding a Business to Buy
As you begin a search for an existing business to buy, you could start with traditional approaches of looking in your community and talking to people in the industry. Or you can take your search online.
You can be matched with acquisition opportunities in your area based on your criteria and connect with a seller. Once you find a good fit, you can discuss the financing, including if seller financing to buy a business is an option.
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