Owner Financing

With small businesses still struggling to access capital, many businesses owners looking to sell their business or many budding entrepreneurs looking to buy a business are finding themselves out of luck.

However, these sellers and buyers can work together - meeting each others needs as well as their own.

Owner Financing

Owner Financing is simply where the owner(s) of the business - finance the sale of that business - they hold the note, so to say. So, the seller of the business also acts as the bank to the buyer (makes the loan).

To protect yourself (for both the seller and the buyer) - you should ensure that you structure any owner financing deal to provide the seller enough in compensation for the additional risk that is being taken (the buyer might turn out to be a bad business owner) and to ensure that the financial burden on the buyer does not set them up to fail from the very beginning.

While the negotiations of the sale price and other terms are beyond the scope here - the following is a brief example of how an owner financed deal can be structured - with additional information on how it benefits the buyer and the seller:

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Example:

Let say that you have agreed to purchase the business (its name, inventory (if applicable), assets, pending revenue, etc.) for $100,000.

So, how can you both structure the deal where both parties benefit and also so that the buyer has an honest chance of being successful in the future?

The first two things you have to agree on is the interest rate (the seller should be compensated for financing the deal just like a bank or other lenders would expect) and the down payment (which provides the seller with some equity up front and ensures the buyer has 'skin in the game' - so that they just won't easily walk away if the situation gets a little difficult).

Determining these two items are again beyond the scope here - but, know that negotiations are an integral part of any buy/sell contract.

Let's say that you both agree on a 10% down payment and an interest rate of 8%.

To be fair to both parties, this deal can be structured as a 25 year amortized contract with a 5 year balloon payment.

How this would work: The buyer comes up with $10,000 (10%) at closing to be given to the seller. The seller then finances the remaining $90,000 for the next 5 years.

However, the loan payments for the loan are amortized (based on) a 25 year term - making those payments much more reasonable or affordable for the buyer.

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Results:

Assuming simple interest here:

This sets the monthly payments at roughly $695 for the first 5 years. (The monthly payment would have been $1,825 monthly had it been amortized for just 5 years). Thus, making easier for the buyer to meet that monthly obligation and still retain enough cash flow to grow the business.

Then, at the end of the 5 years period, the buyer and seller would get together again and the buyer would either pays off the remaining balance (the balloon payment) - $83,047 in this case - or they both agree to refinance the remaining amount - again for another 5 years or whatever is agreed on.

The true benefit here is that the buyer then has 5 years to prove himself as a worthy business owner - getting the revenue up to par and stabilized. Then, after those 5 years (if all goes well) the buyer can then show a bank or lender his track record and established cash flow - making his ability to obtain outside debt financing that much more promising.

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From the buyer's prospective

For the buyer, this situation offers two very strong benefits:

First, if the seller is willing to financing the business - this means that the seller strongly believes in the business's future and not just cutting their loss before the business tanks. This could go a long way in reassuring the buyer about the business's future earning potential.

Second, if financing cannot be obtained anywhere else, this might be the only way that the buyer can purchase this business - and, do so without a lot of the hassles that a bank or lender would require (even thought the seller should do some due diligence).

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From the seller's prospective:

The seller also receives two very strong benefits:

First, selling the business. There has to be some reason that the seller is selling and this could provide the mechanism to facilitate the deal - now - and not having to wait months or years for the right buyer to come along with the right financing in place.

Second, just like a bank, the seller will earn interest on this deal - as further compensation - in this case, should the buyer pay off the balloon payment after the first 5 years, the seller would earn an additional $34,725 dollars over and above the original purchase price.

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