What is seller financing?

If you’re looking to finance a business acquisition, seller financing can help you pay for the purchase over time, rather than all at once. Unlike a bank loan, there’s no third-party lender to worry about, so you can move faster without needing to wait for approval. It’s just between the seller and the buyer.

Here we’ll examine what seller financing is, how it works, the advantages and disadvantages and how to decide whether it’s right for you.

What is seller financing?

Seller financing is a financial agreement between the seller of a business and the buyer. The buyer provides a deposit to secure the purchase, then pays the remaining amount in instalments. 

It works similarly to a mortgage, except that it cuts out the bank or financial institution and you’re in agreement directly with the seller. However, rather than a conventional loan, the seller is providing credit to cover the purchase price, minus an initial down payment. You (the buyer) then make regular payments until you’ve paid back the debt and any charges on top.

How does seller financing work?

As the buyer, you’d normally make a down payment/deposit to the seller, followed by instalments at agreed intervals (eg, monthly) for a specified term and interest rate until the loan is repaid. A bank or financial institution is not involved because the seller handles the loan (in other words, the mortgage) in agreement with you, the purchaser.

Here’s an example of how seller financing works:

The buyer and seller agree to a purchase price of £300,000. The seller requests a down payment of 15%, which is £45,000. The seller agrees to finance the balance of £255,000 at an interest rate of 8% over a 25-year period. The agreement may include a balloon payment, which is a lump sum paid during the loan term. The advantage is that it means lower initial payments.

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Buying a business with seller financing

There are several reasons why you might choose seller financing. For example, you might be unable to get finance because of poor credit. When buying a business with seller financing, the seller is usually more accommodating and there are fewer obstacles and more flexibility in the terms and conditions.

Speed and simplicity are other reasons. It’s often much faster and more straightforward, suiting buyers and sellers alike, and the initial down payment may also be lower. However, the interest rate may be less favourable than other loans.

Alternatives to seller financing

Because of the high cost of property and business purchases, some form of financing is nearly always involved. Thanks to alternative finance, many options are now available, but conventional mortgages remain popular.

With a mortgage, the borrower will make regular payments to the lender over a specified period, to cover the principal plus interest, and the property is used as collateral against the loan. Mortgages are only granted after a rigorous application and vetting process, and borrowers may not meet the stringent requirements.  

An iwoca Flexi Loan as an alternative form of finance. Funds are available for up to £500,000 and for up to two years, helping to bridge financial gaps or shortfalls. There are no early repayment fees, it’s simple to apply for a Flexi Loan, decisions are made very quickly, and interest is applied only to the days when you have the funds.

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The pros and cons of seller financing

Pros for buyers

• Alternative finance. An option if you can’t secure a mortgage.
• Quicker purchases. Less administration and less time waiting for loan approvals than when dealing with banks and financial institutions.
• Flexibility. Terms and conditions can be negotiable.
• Cheaper closure. No final charges or admin fees.

Cons for buyers

• High interest. Bank interest rates are often cheaper.
• Default terms. If you default, you may lose the property and all payments to date.
• Due-on-sale clause. Seller financing is straightforward if the owner doesn’t have a mortgage. But if there is an outstanding debt, the lender can demand immediate payment in full because of a due-on-sale clause.
• Balloon payments. Some seller financing agreements will require a lump sum payment during the loan term.

Pros for sellers

• Quicker sales. What’s faster for the buyer is also faster for the seller.
• Regular income. Sellers gain a regular income without the responsibility of owning and maintaining the property (like landlords).
• Sell ‘as-is’. Sellers don’t need to comply with any pre-sale repairs that traditional lenders might require.
• Investment potential. Interest on payments may offer better returns than if money was invested elsewhere after a full sale.
• Wider buyer interest. Seller financing may help attract more potential buyers.

Cons for sellers

• Managing payments. Sellers must keep track of payments and ensure they are regular.
• Risk analysis/trust. Sellers must do due diligence to be confident that purchasers are credit-worthy and can maintain payments.
• Default. In the event of default, sellers must handle the foreclosure process and repossess the property.
• Need to clear existing mortgage. In traditional sales, the seller uses the proceeds of the sale to clear the debt. With seller finance, sellers may not have sufficient funds up front to clear the mortgage.

Seller financing terms

Balloon loan. A loan that isn’t fully cleared over its term. This necessitates a balloon payment, which is an inflated one-off payment to clear the balance.

Promissory note. This is a legal instrument, detailing the sale terms and conditions, forming the basis of the deal between the buyer and the seller.

Due-on-sale. A mortgage clause that requires borrowers to repay lenders in full when the property is sold.

Closing costs. Fees paid at the end of the sale by either the buyer or the seller. For example, commissions, taxes, title and record filings.