Seller Financing Risks
In most cases, seller financing may prove to be prudent and profitable. However, this is not the case for all businesses as many seller-financed business offerings come with many risks. Here, we discuss the risks to seller financing.
It is very important for sellers to be conscious and attentive to the risks involved. Before taking on such a decision, sellers should evaluate the seller financing as a business investment. This investment involves the seller to stay with the business (shareholder/lienholder) until the buyer is able to pay the principal with interest. If the buyer is not able to do so, the seller may miss the interest and costs that are associated with collecting the debt balance. Thus, sellers should be sure and confident that the buyer will be able to stick to his promise and goal of paying the entire debt before initiating the deal.
Once decided, sellers should not give up the buyer’s down payment on the business, as this reduces the risk of allocating a larger portion of ownership to the buyer(s). The seller should plan to finance not more than one-third to two-thirds of the total business sale price. In other circumstances, where the seller holds a significant personal interest in the deal, financing more is acceptable and viable. Thus, the higher the down payment amount, the lower would be the risk involved.
Many sellers view seller financing as the last attempt to sell their business. However, these deals actually offer many benefits that other cash sales do not. Sellers have an advantage of selling their businesses for twenty per cent over the cash sale value. Moreover, sellers can enjoy interest payments and tax benefits. Most seller financing deals bring in an average of 8-10% over a five-year period.
It is advisable to get some third party help to avoid all complications during the transaction. Many structures and policies have a legal and financial view attached to them. Moreover, it is a great idea to get a business appraisal from an unbiased party. This will help both the buyer and the seller know the true value of the business. Thus, getting help from financial and legal professionals and consultants will help reduce seller financing risks--don't write a seller finance contract on your own--get a professional to do it.
It is important for the seller to be sure and confident that he is taking the right step. It is also important to do some homework and, to some extent, rely on gut feeling. Going against it could lead to regret. Truly, acting as a bank could help the seller by selling the business quickly, but it is mandatory for all sellers to assess their situation before taking on the decision of seller financing.
Gaebler, a resource for small entrepreneurs offers a great guide on seller financing along with associated risks to consider.
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