Seller financing is often a great option for covering the costs of a business that’s for sale. Sometimes called a seller’s note, this form of financing is a loan the present owner of the business offers a prospective buyer to cover part of the acquisition costs or to build the liquidity reserves that are needed after the sale.

How does this arrangement work?

Sellers who offer financing act as lenders, providing some portion of the capital that’s needed to buy a business. Buyers who take part in seller financing agree to repay the seller, with interest, over a fixed period of time.

Can I use seller financing and other forms of financing?

Yes. Many business buyers choose to combine multiple sources of capital to come up with the money they need to buy a business.

Why would I choose to pursue this form of financing?

You might choose seller financing in any of the following scenarios:

	You don’t have enough cash on hand to buy a business outright.		You’ll need to access capital quickly.
	You’re unlikely to meet a bank’s lending requirements.		You need help covering the down payment requirements of an SBA loan or another form of financing.
	You’ll want to access capital with favorable lending terms.		You want to see that the seller believes in the future of the business with you at the helm.

Can I use seller financing to cover my business loan down payment?

Often, you can apply seller financing to cover part of your loan down payment. But let’s take a step backward for a moment.

If you plan to use a term loan or SBA loan to buy a business, your bank will likely require a down payment (often totaling 10 to 20 percent of the business’s purchase price). When seller financing is used toward that down payment, buyers can bring less cash to closing.

Here’s something important you should know: Buyers must cover at least half of the down payment with personal assets.

Here’s what that might look like in a loan that requires a 10% down payment:

• The lender provides financing for 90% of the purchase price of the business.
• The buyer covers 5% of the price, which goes toward the required down payment.
• Through a seller’s note, the seller covers the remaining 5% of the price, which is also applied to the required down payment.

Why does this matter?

By applying seller financing to your down payment, you may be able to afford a significantly higher-priced business that’s for sale. Consider the following example:

Kim owns a commercial cleaning business, and she plans to buy a similar operation outside her current geographic market. She has $50,000 in cash to use for a down payment, and she plans to take out an SBA loan to cover the rest of the costs. SBA loans require at least a 10% down payment, so without another source of financing, the highest price Kim can pay for that business is $500,000.

If she can find a seller who will cover half of the 10% down payment, or 5% of the total price of the business, Kim’s $50,000 could stretch further. She would only need to cover the remaining 5% of the down payment. If she applies her full $50,000 to this requirement, she could afford a business that’s priced at $1,000,000.

Are sellers ok with this practice?

Sellers aren’t always open to this option. Some offering seller financing stipulate that their financing cannot be used toward a down payment. Here’s why. Any portion of financing sellers provide that’s applied to the down payment of the business cannot be repaid to the seller until one of these conditions occurs:

In other words, sellers can’t receive loan payments until the SBA loan is either paid off or refinanced into another loan type.

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Let’s work through an example to illustrate how this works:

Ashley is a buyer who will be paying $500,000 to buy Vince’s business. Vince has agreed to provide seller financing up to $25,000, or 5% of the price of the business. Ashley also has cash that she plans to apply to the purchase. She has decided to apply for an SBA loan to cover the balance of the purchase price.

Vince’s offer for seller financing did not specify whether it could be used to meet a down payment requirement, so before proceeding, Ashley must choose one of the following courses of action:

1. 1. She can opt to apply the seller’s note toward the $50,000 down payment the SBA requires to finance the business. Vince’s seller’s note will cover half of the down payment, and Ashley will need to come up with the remaining $25,000 to cover the rest of the down payment.
      
      When is the seller repaid? Vince cannot receive repayment until Ashley has either repaid the entire balance of the SBA loan or refinanced the balance into a non-SBA loan option.

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1. 2. She can choose to subtract Vince’s $25,000 seller financing from the price of the business before applying for financing. In this scenario, Ashley would apply for a $475,000 SBA loan to cover the $500,000 business. She would need to come up with $47,500 of money that isn’t Vince’s to cover the down payment.
      
      When is the seller repaid? Vince could begin receiving repayments from Ashley immediately because no part of the seller’s financing was included in the down payment.

The takeaway is that buyers can repay any seller financing that’s not applied to the down payment of the SBA loan at any time, following the terms that the buyer and seller set.

How do I set up a seller financing arrangement for a business that’s for sale?

First, and most importantly, the seller will need to agree to the arrangement. Many readily agree (or can be persuaded to agree) for two reasons:

1. The arrangement is a loan that allows them to earn interest, raising the total amount of money they walk away with from the sale of the business.
2. There may be tax advantages for sellers who accept smaller payments over time rather than a single lump sum.

Next, the seller will need to provide you with the terms of the arrangement. Terms can vary, but some of the terms that are commonly used are described below:

Most sellers offer loans between 10-15% of the purchase price, but loan amounts up to 40% are not unusual. Few sellers lend more than 40% of the purchase price.	Most sellers agree to a payback period of 5-7 years to provide buyers time to work through the transition, implement new practices, and repay any obligations that take precedence, such as SBA loan down payments that were made with seller financing proceeds.	Many sellers mirror the interest rates that are offered by competitive financial institutions. Some may match or offer slightly lower interest than market loan rates. Others may ask for a higher interest rate for less creditworthy buyers.

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If the seller sets favorable terms, you may want to “apply” for their loan. If you do, the seller will check your creditworthiness, financial qualifications, and background. They might also ask for your reasons for wanting to take on debt to buy the business. Some will also ask for your resumé to see if you can run a business effectively, as well as a business plan that maps out your proposed strategy.

These two documents aren’t often requested of buyers in other scenarios, but sellers take a risk by offering financing. They want assurance that the business will be in good hands and endure long enough for them to be repaid in full.

A quick note: The seller has the right to deny financing, and if that occurs, you’ll need to pursue another source of funding. The seller also has the option to present less favorable terms for buyers who are less creditworthy. Some may ask for a large down payment, a higher interest rate, or collateral to secure the loan.

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After credit, background, and other verifications are complete, the seller will work with an attorney to draft a loan contract. You and your attorney should review this contract carefully to ensure you understand the terms, courses of action the seller can take for missed loan payments, and outcomes that can result from defaulting on the loan.

Would you like to connect with an attorney? Start here:

Which other forms of financing should I consider?

Beyond seller financing, there are lots of other way to cover the costs of a business that’s for sale. Check out this article to learn about other funding options, including SBA 7(a) loans, term loans, asset-backed loans, and 401(k) options:

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