Should You Agree to Sell Your Business Through Seller Financing?

In the context of an M&A mandate, the parties have several financing options to facilitate the transaction. Among these are earn-outs, and seller financing, which we will examine in this article.

Seller financing is a common method in business acquisition transactions, allowing the seller to offer payment facilities to the buyer.

However, although this practice offers numerous benefits for both parties, it also carries risks that the seller should carefully consider.

I. Seller Financing: A Solution to Facilitate Transaction Activation

Seller financing is an ingenious method of funding for business acquisitions. Similar to an earn-out, this method allows for the distribution of the payment of the asset over a given period:

  • Right: The buyer makes an initial payment, then spreads the balance over several installments over a period of 2 to 3 years, with a negotiated interest rate.
  • Obligation: Seller financing should not exceed 50% of the sale price, with the balance covered by a personal contribution or a bank loan.

This mechanism facilitates the acquisition by distributing the risks, thereby enabling clients to complete their transaction.

a. Fully Exploit the Opportunities of Seller Financing

Seller financing facilitates the completion of the acquisition by:

  • Facilitating the transaction: Seller financing enables the sale even when the buyer has limited immediate liquidity.
  • Increasing the sale price: By offering favorable payment terms, it allows the seller to achieve a higher price and find a buyer more quickly.
  • Tax advantages: It allows the deferral of capital gains taxation, which can be advantageous for small businesses, subject to eligibility for certain tax optimizations.

b. Perspectives of the Seller and the Buyer: A Contrasting View

Seller financing proves to be an attractive solution for the buyer through various significant advantages it offers:

  • Speed and flexibility: Seller financing allows the buyer to quickly obtain the necessary financing without relying on the usual delays of banks.
  • Reducing the need for external financing: By negotiating terms directly with the seller, the buyer can improve their initial cash flow, adjust interest rate conditions, and avoid additional processing fees.
  • Simplifying guarantees: Often free of complex guarantees such as a mortgage or collateral, seller financing eases the burden and obligations on the buyer, while strengthening trust between the parties.

For the seller, this practice allows them to sell their business at a fair price while having the opportunity to select a competent buyer, even in the case of the buyer having limited personal funds. The benefits for the seller are thus varied:

  • Operational: Facilitates the sale at a fair price and allows for the quick selection of a competent buyer, regardless of their initial financial means.
  • Financial: Generates additional income through the interest on the loan granted to the buyer, which can represent a significant sum depending on the sale amount and the agreed interest rate.
  • Tax: Offers the possibility of benefiting from a deferral of capital gains taxation under certain conditions, allowing for the deferral of tax payment over a maximum period of 5 years.

II. Essential Terms of Seller Financing

  • Amount and repayment duration: Generally between 30% and 50% of the sale price, over a period of 1 to 3 years.
  • Interest rate: Negotiated between the parties. The negotiation depends on the seller’s needs and the buyer’s repayment capacity. The interest rate is generally aligned with that of banks, but a zero rate can also be considered.
  • Guarantees: Surety, pledging of the business assets, mortgage, etc. A bank guarantee may also be requested by the buyer.
  • Formalization: A notarized deed is recommended to secure the agreement. Ideally, the negotiated terms between the seller and the buyer should be included in the letter of intent.

III. Succeeding with Seller Financing: Strategies and Precautions

a. Identifying and Managing Potential Drawbacks

  • Careful analysis of the buyer’s profile: Reputation, history, etc.
  • Risk of non-payment: There is a risk that the buyer may default, which could compromise the seller’s financial security.
  • Leverage: The seller has leverage to demand a higher price.
  • Increased financial burden: For the buyer, seller financing payments add to other financial obligations. It is crucial to plan the repayment of seller financing in such a way as not to affect the company’s cash flow after acquisition.

b. Key Factors for Successful Implementation

  • Mutual trust: Establishing a trust-based relationship between the seller and the buyer is essential for the success of the transaction.
  • Buyer’s skills: The buyer must demonstrate their ability to effectively manage and develop the business after the acquisition.
  • Seller’s compromise: The seller must make concessions, considering the increased financial burden the buyer will bear, and be willing to take on some risks in the operation.
  • Professional guidance: It is recommended to use legal and financial advisors to structure and secure the transaction.

In a nutshell:

At OutMatch, we are trusted partners, specializing in supporting our clients in their M&A transactions by providing our expertise, creativity, drive to succeed, and innovative solutions to advise you and help you make the best decision for your business.

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