Basics of Seller Financing

According to statistics, nearly 80% of small businesses include some form of seller financing. What is seller financing and should you consider it? This short article will address these questions and help you determine if you should finance a portion of the sale.

What is seller financing?

Seller financing is very simple. The buyer makes a down payment (usually 40-60%) on your business and then makes payments over a period of time (typically 3-5 years). Many sellers of businesses get confused and think that they have to lend the buyer money; this is not true. The buyer is simply making a down payment and then making partial payments over 3-5 years.

How can I protect myself from the buyer not paying?

Because you are financing a portion of the sale, you should act like a bank does and prescreen or qualify the buyer before committing to them. It would be a good idea to get a detailed financial statement, credit report, resume and any other pertinent information you can get on the buyer. It also makes sense to select a buyer whom you think has a pretty good chance of doing well in the business.

Most of the problems I see arising from this come from the seller accepting a very low down payment (5-20%). Few buyers will walk away from a large down payment (30%+). I wouldn’t suggest anything less than a 30-35% down payment.

Are there any other ways I can protect myself?

Yes. A strong promissory note should be drafted with clauses that directly address non-payment and late payments. A UCC lien should also be filed on the business, preventing the buyer from selling the business or the assets. These documents should either be drafted by an experienced escrow agent or attorney.

What interest rate is fair to charge?

Historically, over the last ten years, the rates charged on promissory notes have ranged from 6-10%. The rate does not depend on the current cost of money, but rather depends on the risk involved. I often tell buyers this and most understand. Some buyers say that current rates on mortgages are 4-5% on the rate should be competitive with these. I explain to the buyer that there is a lot of risk involved for the seller and very little collateral other than the undervalued assets of the business.

The bottom line is that you could probably ask anywhere from 6-10%. 10% might be a little high considering the current economic condition. Other factors should be taken into account when determining the rate to charge, such as the total price of the business, the buyers credit score, the buyers experience, the buyers financial position, and probably most importantly, the down payment.

How many years should the note be for? (Amortization period)

Most notes range from 3 to 5 years. Common sense is the rule of thumb here. The buyer must be able to make the payment of the note from the cash flow or profit of the business. Let’s look at a very simple scenario:

Dumb Scenario – Won’t work

Price of Business: $200,000
Down Payment: $100,000
Amount financed: $100,000
Term 2 years
Interest Rate 8%
Monthly Payment $4,522/month
Annual Payment $54,272
Annual cash flow from business $100,000
Minus annual debt service


Profit left over after debt service $45,727


This scenario obviously won’t work because the payment is more than half of the annual profit of the business. A more realistic scenario would be a 4- to 5-year term. Note that the interest rate does not play a huge role in terms of the payment amount. The payment probably shouldn’t exceed a third of the annual cash flow of the business. If the cash flow of the business is very stable from year to year, then perhaps it could be a little higher. If the cash flow is very inconsistent, then you should build in some cushion room and structure the note so the payment is lower.

Is there anything else I should keep in mind?

Yes. Make sure you remain on the lease during the entire period of the note. If the buyer defaults, you will want to be sure that you can take the business back and repossess the lease. You could get approval from the landlord under this scenario. Again, this should be addressed by a highly experienced broker or attorney. It is unlikey an escrow agent will be familiar with how to handle this.

What if I need the money in a year or two?

You can often sell the note after it matures for about six months. There are tons of people that purchase these notes and buy you out. Unfortunately, it is often at a steep discount, but there aren’t many other options.

What are the benefits to financing a portion of the sale?

  • Lower taxes - You don’t pay taxes until you receive the money. (Be sure the note is “non-negotiable”. This is technical and again, should be addressed by an experienced advisor.)
  • Higher selling price - Businesses that include seller financing sell for 15-20% more than businesses that sell for all cash.
  • Faster sale - In my estimation, businesses sold with seller financing are two to three times easier to sell than a business sold for all cash.

Should I offer the business for sale with seller financing or wait to see if the buyer requests it?

It is best to offer specific terms when advertising your business for sale. This tells the buyer that you are serious and realistic in terms of the sale. Buyers like to deal with realistic sellers. You will definitely get more activity on the business if you offer terms in your advertising copy.