Steve Strauss, founder of www.theselfemployed.com, explains the concept of seller financing and how/when it may work for buying a business.
Q: I have been offered a chance to buy a business and the owner is willing to finance part of the purchase. What I mean is that I cannot afford the $50K he is asking but he said he would be willing finance half the cost over 5 years if I could come up with the other half -- $25,000. It seems too good to be true. Is it?
A: It depends on why he wants to finance the business. Usually, a business owner will finance the sale of his business because
- It's a slow market and/or a bad economy. Seller financing helps make a sale more possible when times have been tough.
- The seller is highly motivated to sell. Maybe he is getting divorced, or is having some health problems. Whatever the reason, he needs to move on in his life, pronto.
- It’s a bad business. If the seller cannot sell his or her business the old-fashioned way – via a broker and getting the buyer to pay 100% -- it may be because the business is akin to that car that is a lemon. The owner figures that financing the business will at least make it someone else’s lemon.
So you have to figure out if it is the first, second, or third reason. If you conclude that it's a legitimate business, then seller financing is great for all concerned because it makes the sale much easier. Here’s why:
As in the case above, the buyer need only come up with $25K. Or, in the case of, say, a business that is worth $100,000 maybe the buyer still has only $25,000, and the owner is willing to finance $35,000. A lender would be much more likely to lend the rest ($30,000) because its exposure is less when the owner helps with the financing.
Generally speaking, buying an existing business is usually a very good idea, for several reasons:
- First, there is less risk. You can review the books of the business and get a pretty good idea as to how much money you can expect to make.
- Second, there is the built-in clientele.
- Third, you do not have to spend years creating a brand; goodwill is already established.
- Finally, it is sometimes possible to get the present owner to stick around for a while (six months or so) in order to teach you the business.
That said, buying good businesses can be an expensive proposition, and so then the question is: How do you get a seller to finance part of that purchase?
It’s not as uncommon as you may think. This sort of financing is well known in the real estate industry where the owner agrees to “carry the paper” for the buyer. The homeowner’s note is usually recorded as a second mortgage and is paid off in due time. The same idea is at play with owner financing in the sale of a business. The owner carries the paper and is paid off over time.
Why would an owner do this? The truth is, business owners don’t usually want to and only agree to it when they have no choice. Usually, a seller will try to sell the business and, if unsuccessful, becomes like the homeowner whose house has been on the market too long: They want to get out and will look for creative solutions.
That’s where you come in.
By offering the owner a way out, a chance to sell the business if they carry some paper, you become a solution to their problem.
Are there risks? Of course, this is business after all. The main one is that the buyer will default on the loan and the owner will be forced to repossess a business he no longer wants. But a business owner can diminish the likelihood of that happening by doing some due diligence. The seller must check out the buyer as much as the buyer must check out the seller and the business. The seller must become comfortable with the buyer’s ability to successfully run the business. The seller must do a background and credit check on the buyer and secure the deal with collateral.
But once everyone agrees that the other party and the business are on the up-and-up, then seller financing is a creative way to solve everyone’s problems.
Today’s Tip: Where do you find possible seller-financed businesses for sale? The places to look include: Craigslist (“Businesses for sale”), the Businesses for Sale or Business Opportunities classified section of your Sunday paper, the back of industry magazines, websites listing businesses for sale, and business brokers.
The key is to find an ad for someone who is willing to “carry the papers,” or who is “motivated,” or who says “financing is available.” Those are the magic words.