Seller Financing & Deal Structuring 401

Our goal here is to demystify seller financing and deal structure with examples from real, recent deals.  

Let’s begin with a “typical” deal structure for a small or medium business sale:

• – 80% financed by commercial lender (this could be SBA-insured financing)
• – 10% buyer capital
• – 10% seller financing

This would be a textbook “plain vanilla” small business deal.

Now, deal structure varies greatly based on the type of buyer and many aspects of the business itself (industry, size, location, and outlook).

Too often, sellers are laser focused on the transaction price, aka selling price.

Deal structure, especially in our current environment, is just as important as the transaction price.

Recently we had a buyer submit 4 different deal structures, allowing the seller to pick their preference. The transaction price varied $225k across the 4 options, and the mix of seller financing ranged from 5% – 25% of the deal. Also in play was the term (length) of the seller financing and how many years the payments would be “on standby” or interest only.   

So, what do we mean by deal structure?

The mix of cash at close, asset vs stock sale, seller financing, any earnout or contingent payments, rollover equity, and the amount of time an owner must stick around after a sale.

As of the time of writing, the WSJ Prime Rate is 8.5%. Most commercial lenders have a 2.25% – 3.00% spread that they layer on; meaning an SBA-insured loan for a prospective buyer will typically be at a ~10.50% rate for a standard 10-year term.

You are probably starting to see why seller financing has become more important in the last 18 months.

Seller Financing 101

You have bought something on Amazon, right? Of course you have.

Let’s say you’re searching for an item and not exactly sure what you want.

Amazon presents many ways to filter the bewildering number of options: price, brand, reviews, features, weight, availability, etc.

What’s the 1 “filter” box nearly all of us click?

Prime.

Why?

We want free shipping.

Now, in selling a business,

Amazon Prime = seller financing available.

We advise every owner we work with to empower us to confidentially market their business as seller financing available even if it is not an appealing option for the owner.

Why? Because it is one of the first ways a prospective buyer will filter down the many options presented to them on business for sale marketplaces.

Keep in mind, marketing a business as “seller financing available” does not mean that seller financing will be a part of the deal. It merely keeps these buyers in the mix and ensures your business is on their radar.

On business for sale platforms, we often include this language:

Seller financing up to X% is available, at a market-rate interest rate, for buyers with appropriate financial qualifications and operational experience.

Couple notes:

1. Buyers (and their lenders) see a seller’s willingness to finance part of the deal as a strong vote of confidence in the continued success of the business
2. We advise on a market-rate interest rate, term, and appropriate language to protect you
3. IF seller financing is going to be part of the deal, we tell buyers that as a lender you are no different than any other bank. Meaning they will be required to provide credit information, sign a legally binding note, and a lien will be placed on the business or their personal assets. All standard practice to protect both parties

To a prospective buyer, and their lender, a seller’s willingness to finance part of a deal (it can be small) is an important signal that they believe, and are financially invested, in the continuity of the business. This is by far the primary reason buyers and lenders want to see some amount of seller financing. A secondary benefit is to the lower the buyer’s financing costs (interest expense).

Let’s look at several recent deals to better understand deal structure, note each of these businesses was in a different industry and each deal was financed by a different lender.

Deal #1

• 90% cash at close
• 10% seller financing (5-year term, 7.0% annual rate, fixed monthly payments)

Deal #2

• 95% cash at close
• 5% seller financing (10-year term, 7.0% annual rate, full standby meaning the loan and accrued interest are due in full in 10 years)

Deal #3

• 85% cash at close
• 15% seller financing (10-year term, 7.0% annual rate, first 2 years are interest only payments)

Notice all three deals involved a 7.0% annual rate for seller financing. Currently we advise sellers and buyers that a ~7.0% – 8.0% annual rate is market appropriate. This tends to work well for both seller and buyer; sellers need to be compensated for assuming some risk and buyers are afforded some flexibility on transaction price with a cost of capital (interest rate) that is lower than what they can obtain from their lender.

Generally, we advise against seller financing exceeding 25% of the transaction price. We have seen some sellers open to exceptions for buyers that they personally know or are friendly competitors.

Until 18 months ago, it was rare that seller financing exceeded a 5-year term. Now it is rare to see less than a 5-year term.

We are frequently seeing 7, 8, and 10-year terms on seller financing. In addition, many lenders are starting to require that any seller financing be “interest only” or “on standby” for the first 2 years. This gives a buyer (new owner) time to get comfortable as an operator and reduces immediate cash flow pressure after a deal. Payments could be interest only, meaning the principal is deferred, or the seller financing could be on “full standby” meaning there is no interest or principal payments for some duration.

A seasoned M&A Advisor can help you negotiate, guide you through options, and ensure you are protected.

In our next post, we will continue discussing deal levers, including earnouts, rollover equity, and transition periods.

Hopefully, you are a little smarter on deal structure after reading. As always, thank you for reading.  

At Washington Business Brokers we are experts in valuation, optimizing a business for sale, buyer identification and qualification, negotiation, deal structuring, and closing.

If you would like to better understand the value of your business or learn more about the process of confidentially selling:

call or text 206.703.3555
email info@wabusinessbrokers.com
or schedule time for an exploratory, free consult

100% confidential, always.

When the time is right for you, we will be proud to partner and advise on your fair deal.

Want to learn more? 

Start with our 2024 guide to selling your business or check out recent market data and multiples.