Why Owner Financing Is A Business Seller’s Best Friend
Are you thinking of offering seller financing to your potential business buyers? Below are 5 advantages of selling your business with this strategy. Though this is not an exhaustive list, it highlights the most important benefits of seller financing for business sellers.
1. It can increase the number of potential buyers.
Since most potential business buyers will not have the funds to purchase a business with cash and some may not qualify for a business loan, the absence of seller financing can drastically decrease your chances of finding a good buyer.
2. A business owner can sell their company at higher price.
When business sellers utilize owner financing as part of their deal structure, they are able to sell their companies at a higher price and buyers are willing to pay it. A potential business buyer is more likely to purchase a business with a higher price tag and a seller financing option than a business that requires all cash payment but a lower sales price. Why? Because the buyer is not likely to have the funds to close on an all cash deal but may be able to close easier if they had less funds to come up with upfront.
3. A buyer’s installment payments may be tax deductible.
A business owner that sells their company with owner financing will pay fewer taxes to the IRS than if they sold their business for cash. The IRS considers any business that is sold through seller financing to be an installment sale. This means that your capital gains tax liability gets spread out over the course of the contract instead of paying taxes all at once. For example, a business seller offers seller financing to a buyer and receives monthly installments from the buyer for 5 years; the business seller is taxed on the payments they received per year. If the business seller collected the entire purchase price from their buyer, they would have had a larger tax liability since the sale price was larger than spreading it out for 5 years.
Note that in order for the installment payments to be taxed at a lower rate, the seller must allocate the deferred payments to assets that will be taxed at a capital gains rate. They must also be willing to accept installment payments that count toward the purchase price of their business.
4. Potential to earn future profits.
One advantage of seller financing is the potential to see the new buyer grow your company. The new buyer may have experience and resources to take your company to a higher level of financial success. A business seller can take advantage of future profits with an earn-out clause in their sales contract. An earn-out clause is a payment made to business sellers based on the future financial performance of a business.
5. A business seller has the potential to sell their note for profit.
When a business is sold with seller financing, a promissory note is typically created. These notes usually have terms of between 2-10 years. Similar to seller financing notes on real estate, business promissory notes can be sold to a private or institutional buyer for cash before its maturity date. This can be an advantageous option for sellers that prefer to recoup their investments sooner than at the end of the note’s term.
For example, a business owner sells her company with a five-year promissory note for $500,000. The business owner decides to hold the note for two years and sell it to a note buyer for $600,000. Instead of collecting monthly payments from the buyer for 5 years, she can receive $100,000 profit (and three years sooner).