It has traditionally been a common practice for the sale of a privately-held small business to include some seller financing as part of the deal structure as a lender's effort to reduce their own risks and may be the key to getting a deal done.


Seller financing can accomplish several goals beneficial to both parties. From a buyer's perspective, most buyers feel there is a risk that the success of a small business is tied to the involvement of the owners. By having the seller finance a part of the purchase price, it can give the buyer confidence in the fact that the seller believes the business can thrive without them. From the seller's perspective, seller financing can help a buyer pay more for the business than if the deal were financed only through traditional financing sources.

With that in mind, it is important to remember that the purchase/sale of a business is a two-way street. Just as a buyer will conduct due diligence to determine the viability of the business, become comfortable with its financial and legal matters, and assess the opportunities for growth, a seller should be comfortable with the buyer as well, particularly if the offer includes a loan by the seller. The seller should understand the buyer's business background and qualifications, motivation for buying the business, and financial capacity to purchase and sustain the business.

Business owners who extend financing to a buyer for the purchase of their business often ask, "What happens if the purchaser defaults on the loan?" Should that happen, the seller would be able to exercise whatever rights are defined in the security agreement that is associated with the promissory note. The seller would usually have the right to get the business back, which may not always be the best scenario if the business has declined under the buyer's management and is not performing well. In addition, if the buyer is using the business' assets to get a bank loan, the seller will have to take a second position behind the bank. A seller should try to negotiate a personal guarantee by the buyer as part of the terms of the promissory note. The seller can also require the new owner to provide periodic financial reports on the performance of the business as part of the terms of the promissory note.

While it is important for a seller to protect themselves should a default occur, keep in mind that seller financing is often required for a reason, such as lack of bank financing, risks in the business, or to bridge a value gap. In other words, seller financing may be required in order to get the deal done.

Regarding the interest rate to be paid for the seller note, if the seller note is in conjuction with a bank note, it is hard to substantiate a rate much higher than the bank since a buyer is generally utilizing seller financing as a bridge mechanism to help the seller attain his or her price.

In the course of the seller's due diligence on the buyer, it is acceptable to ask for their credit record, particularly if the buyer is an individual. Personal credit records are available through several outside services, as long as written authorization is given by the individual being checked out. There are standardized forms that can be used whereby the buyer grants permission for the seller to obtain credit reports from specific consumer reporting agencies. Many of these credit companies can be queried via the Internet, such as Equifax, Experian, and TransUnion. Another service that doesn't require authorization is AAA Credit Screening Services. If a fee is charged to obtain the reports, the buyer can be asked to cover it. The seller may also ask the buyer for a list of financial and business references.

Seller financing can accomplish the goals of, and be beneficial to, both parties as long as each feels confidence in the other.