With over 20 years in M&A, I’ve seen the popularity of seller financing shift in response to economic conditions. Recently, with rising interest rates and cautious lending practices, seller notes have become more common. But what exactly are seller notes, and how should you approach them?
What is Seller Financing?
Seller financing, or a “seller note,” is where the seller provides a loan to the buyer to cover a portion of the business purchase price. With banks tightening lending, sellers are increasingly asked to step into this role to bridge financing gaps. This approach is common in today’s high-interest, cautious lending environment, especially in deals under $10 million.
Why Consider Seller Notes?
While seller notes come with risks, they can offer strategic benefits:
- Potential for Higher Sale Price: Offering seller financing can attract more buyers and potentially raise the total sale value.
- Tax Deferral: By structuring payments, sellers may defer taxes.
- Operational Advantages: Buyers who are operationally strong but financially limited may still be able to purchase, benefiting from your industry insights and experience.
Common Risks and Mitigation Strategies
Though useful, seller notes have inherent risks. Key risks include:
- Second Position: Seller notes are usually subordinated to bank loans, meaning repayment comes second to the primary lender.
- Unsecured Loans: Prime lenders often secure all available collateral, leaving seller notes unsecured.
To mitigate these risks, consider the following:
- Perform Thorough Due Diligence: Evaluate the buyer’s financial history, operational skills, and any co-investors or partners.
- Request Guarantees: Seek personal guarantees or liens on business assets.
- Regular Financial Reporting: Require quarterly financial updates from the buyer to monitor their financial stability.
When to Avoid Seller Financing
Not every deal is suitable for seller financing. For example, when buyer capital is minimal or their financial strength is questionable, seller financing may introduce unnecessary risk. It’s critical to weigh these factors and consult with M&A advisors and legal experts before proceeding.
Summary
Seller financing has long been a part of private business sales, adapting with economic shifts but remaining a valuable transaction tool. Although seller notes carry significant risks, they can be instrumental in maximizing sale value under the right circumstances. Business owners should carefully assess the benefits and risks to make a well-informed decision that aligns with their financial and strategic goals. For a confidential discussion on your business sale options, reach out to our experienced M&A team.