Banking on Your Buyer – How Seller Financing Can Seal the Deal

What is Seller or Vendor Take Back Financing? Seller financing or vendor take back financing (VTB) is an agreement with your buyer to finance the sale of your business. Vendor take back financing can cover the entire amount or a partial amount of the total sale price. Buyers will often use a combination approach when purchasing your business. VTBs are a good way to bridge the gap between the buyer’s available funding and the total purchase price.

How Does it Work?

Seller financing involves the buyer issuing you a promissory note or a vendor take back note. You become like a bank for your buyer by agreeing to lend them a portion of the purchase price. This financing extends the timeline of the purchase as your buyer makes payments to you according to an agreed upon schedule. There are benefits to employing vendor take back financing for both you and your buyer.

Vendor Take Back Benefits

Continued Involvement

Vendor take back financing guarantees your involvement during the transition period. You can continue providing guidance for the next steps of your business post-sale.

Seller Confidence

Offering financing shows your confidence in the future of your business. Your buyer is assured of your vested interest. Some buyers even insist on some level of seller financing as a show of your good faith in your business.

Attract More Buyers

You will attract more buyers by offering seller financing. Competition for your business will be greater when buyers know that seller financing is available. Otherwise qualified buyers missing the necessary capital can throw their hats into the ring.

Faster Closing

Businesses offered with seller financing are easier to sell than businesses offered for all cash. Your indication of confidence can also open opportunities for the buyer to secure other financing options. The faster your buyer secures financing the faster you can close the sale.

Higher Selling Price

Businesses that include seller financing typically sell for 20% to 30% more than businesses that sell for all cash.

Steps to Seller Financing Success

Legal Document Checklist

The legal documents needed to finalize a vendor take back agreement can include:

  • Bill of sale transferring tangible business assets to the buyer.
  • Purchase of assets agreement or bulk sale documents that detail the sale of inventory.
  • Employment or consultation agreement if you are continuing to formally assist with the business transition.
  • Letter of Interest (LOI) detailing the preliminary non-binding agreement that states both parties’ intentions to enter negotiations for the sale of the business.
  • Purchase agreement or deal contract which includes the final terms of your business sale.
  • IRS Form 8594 documenting how your assets will be allocated during the purchase.  (US owners)
  • Notarized non-compete agreement from you to your buyer.
  • Promissory notes detailing the terms of loan documents for your seller financing agreement and any other financing sources.
  • Security agreement that discusses when and how collateral will be forfeited in the case of loan default.
  • Signed lease for commercial property under the buyer’s name.
  • Documents transferring ownership of company vehicles.

Tax Advantages

You pay taxes only when you get paid. Receiving payments in installments allows you to pay taxes gradually instead of in one lump sum.

  • A business sold through seller financing may be considered an installment sale by your country’s government.
  • If the sale is completed entirely with cash, you may pay a short-term capital gains tax on the whole amount.
  • Offering seller financing may allow your capital gains tax liability to be spread out over the duration of the contract.
  • Sales involving seller financing might be eligible for tax deferrals if you are willing to accept payments in installments and if you agree to apply payments toward the value of your capital assets rather than the value of your business. If you are slowly relinquishing your capital assets over time through monthly payments, your capital gains tax rate will be lower on assets held for a longer term.

When Your Buyer Doesn’t Pay

Prequalifying your buyer before offering vendor take back financing is a best practice. However, even if a buyer sails through background, credit and financial screening they might still end up defaulting on their loan. In the end, you must rely on your intuition to judge the buyer’s trustworthiness, and sometimes your intuition will be wrong.

Set expectations by including a solid default provision and financing structure:

  • Minimize your risk by limiting seller financing to 20%-30% of the total business price. The more you finance, the more you stand to lose if the buyer fails to pay.
  • Include a default provision that details litigation and dispute resolution measures for dealing with defaults.
  • Plan resolutions that don’t only include expensive lawsuits. Sometimes other solutions can be reached such as:
    • Holding business assets in escrow
    • Collecting on secured debts such as property or other collateral assets
    • Agreeing to forced mediation or arbitration
  • Forecast planned expenses to create a realistic payment plan your buyer can achieve successfully. The buyer’s debts shouldn’t outweigh their income.
  • Shorter notes are less risky. The longer the terms of the note, the more opportunity for default. Time frames for vendor take back financing can be as long as 5-10 years. However, limiting the duration of the financing agreement to 2-3 years increases your chances of getting paid in full and on time.

The best approach for preventing buyer default is to set up clear repayment expectations and default consequences at the beginning. If your buyer starts missing payments, your best chance for resolution is enforcing the measures you both agreed upon at the outset of the seller financing contract.

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