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Sell a Business: Seller Financing Series: Determine the term of seller financed note

As you work with you business broker to plan the details of a sale, its good to have a overview understanding of how seller financing works because that is part of a majority of business sales.

If you are really interested in selling your business, then it is important to be mindful of the “competition” in the market for buyers. There are thousands of businesses for sale at any given time and many times a buyer looks at hundreds of businesses before finally choosing one. Though your business is unique, plan to have the terms of sale, and seller financing, be within the range of what a prospective buyer is seeing from other companies.

Amount of Down Payment

It’s not uncommon for a buyer to get a business for about 20% down, so if you considering seller financing, you should be as conservative as possible in asking for a down payment. It is typical to get one times your yearly earnings or seller’s discretionary earnings (“SDE” on the low end) to 50% of the purchase price down (on the high).

SDE is equal to the amount of “benefit” that you receive from the business each year. This number is more than the profit on your tax return or profit and loss statement. SDE is the total amount of money that you make or your benefit as the owner. A quality business brokerage firm can help you discover this number.

Interest Rate

A seller financed loan can have whatever interest rate the parties agree to, but remember that you are not a bank.  This is an investment to you.  Expect a much higher return on your money than you can get in most other investments, usually ranging from 2% above Wall Street Prime but no less than 6% and not more that 12%. (At the time of writing this book, prime is at 3.5%.) The bulk of the seller-financed businesses provide a return of 8% to 10%.

Some sellers, however, prefer to go with a more traditional bank approach and use a “variable interest” rate. For example, the interest rate could be Wall Street Prime + 2%, adjusted monthly, quarterly, or yearly based on the then current Wall Street Prime interest rate. Often there is also a floor and cap on the interest rate, such as not to go below 8% or over 12%.

Term of the Note

The term of the note is the length of time that a buyer has to pay the loan off, the period that the loan is “amortized.” There are several ways to determine the length of the term. A skilled business broker can walk through a process of analyzing the business current profit, the buyer’s living wage needs, rainy day fund, reasonable funds necessary to grow the business, and the amount reasonably available to service debt.

When selling a business, both the seller and the buyer want as much money as possible reinvested back into growing the company rather than taking the money out and weakening the company’s ability to pay. Therefore, the best way to have a “win/win” situation for the buyer and seller is to have a loan amortized for 10 years.  While the loan is amortized over 10 years, we typically set a balloon payment at month 61. Sometimes, according to the quality of the business and the condition of the financials, we will do a balloon payment at month 37.

Therefore (as you may already foresee), the bulk of the payments you receive for the first three to five years are in INTEREST. When the buyer makes the balloon payment, be it at month 61 or 37, it is not far off of the total amount being financed.


Depending on the type of business, it may be necessary to offer a varied payment schedule to account for a variety of business-specific variables. For example, if you are in a seasonal business like a heating, ventilating, and air conditioning (HVAC) company, it might be logical to have the payments due in the summer be higher than the payments due in the winter. Not only will this seem more realistic for you, but also it is important for buyers to be mindful of the ebbs and flows of cash for their business.

Try to arrange the seller note to be paid in the way and at the times that you know the business can be better positioned to pay it. You may actually tell the buyer that they make no payments for three months, but then you would spread out over the rest of the year or maybe schedule it such that during the height of the business season (when the coffers are full), they are actually making double payments.

Also, consider allowing the buyer to get into the business and “get their feet wet” before making payments. I usually recommend 60 to 90 days before the first payment is due. This will help the buyer “settle in” and deal with those various additional expenses that always occur after purchasing a new company, and build goodwill in your relationship.

Seller Earn Out

A seller earn out can be used AS the seller-financed portion or in addition to the seller note. An earn out is typically used in situations where the value of the company is really in the “potential” of the company rather than based on the “past” earnings of the company.

So, for instance, if you have a business that has just signed a multimillion-dollar contract right before closing, this might be a solution for you. In a situation where there is a seller earn out, the business has to make the money BEFORE the buyer is obligated to pay the amount. This type of loan is not amortized until the “target gross revenues” are met. So in the situation where you have already signed a contract for the “extra” earnings, this makes sense.

Seller earn outs are also used when we are trying to bridge the (sometimes considerable) gap between what a seller wants for their business and what the business is actually worth. Therefore, the business is sold on the “potential” of the future rather than the past.  There are times when a business has signed a large contract or there is some other situation that will cause the business to grow in the future without the involvement of the buyer. This means that IF the business does grow and accomplish what the seller claims that it will, then the seller gets an “earn-out” payment. Therefore, the sale price of the business is really based on the projections of the seller.

This is also used in situations when a business has had a downturn in profitability. In this scenario you, the seller, have the confidence that this is just a slight downturn due to external factors (or factors that you have taken care of). We put an earn out in place for the express purpose of getting the buyer to pay what the company was worth, all the while giving the buyer the confidence that the downturn was not long term and you are standing behind this claim.

Financing the sale when selling a business.Myths, Fairy Tales and Urban Legends

Discarding Myths, Fairy Tales and Urban Legends About Seller financing when selling a business.

Have you heard the one about the traveling salesman who goes out to a bar for a nightcap and wakes up in his hotel room with stitches on his lower back – and his kidney missing? Such urban legends – others call them myths or fairy tales – are often told around campfires and are good for an after-hours laugh or two. But what about those business urban legends that can give you pause when entering into an otherwise sound business investment?

Let me guess. You are getting ready to sell your business and everyone is sharing their “advice” and horror stories about things going amiss. Some of the most prevalent of these are the seller-financing horror stories. Did you hear about my brother-in-law’s cousin’s friend who sold his business and carried the note and how he lost everything in the process, his business, his retirement, his wife, his dog. You can just hear the country singer crooning the sad tale. How much of this story is true and how much is urban legend? Are these seller-financing “horror stories” valuable, reliable, and trustworthy information upon which you can evaluate a very safe investment opportunity?

Believe me, as a business broker, I have heard hundreds of these stories and every time, without fail, the person telling the story cannot tell me who, what, when, where or how this particular “horror story” happened. I can, however, point to hundreds of successful seller financing arrangements in business sales, specific examples of not only the business seller getting paid, but getting a much better return on his investment than he would have gotten in the stock market or in many other investment opportunities.

Now, I am not saying that the horror stories that you are hearing about seller financing are 100% false. Sometimes seller financing arrangements fail, but you cannot view those situations in a vacuum. No matter how reliable the source of the horror story that is stopping you from considering seller financing, you cannot compare that situation to your own unless and until you are privy to all of the facts.  Dozens upon dozens of factors go into why a seller-financed deal might have fallen through, hit the skids, or cost someone money rather than made them money. Here are some examples -

  • Where did the buyer come from?
  • What was his previous experience before taking over your company?
  • How was the buyer interviewed and “vetted?”
  • What was the buyer’s credit like?
  • How closely did you examine the buyer’s credit?
  • How was the loan secured?
  • What monitoring protocols were put in place?

If even one of the above variables – let alone the 1,001 others that might derail a sale – were to be overlooked, the deal might get rocky. How much of the failure was caused by the buyer, and not contributed by the seller? Could the failure have been suspected much earlier? And could the seller have better protected themselves from that possibility?

There are so many ways to protect yourself as a seller and there are so many upsides to gain if you finance the sale of your business that you must look beyond the myths, fairy tales, urban legends and horror stories you’ve heard about seller financing to see the facts that lie beyond the fiction.

Risk is a fact of life. That was true when you started your business and is just as true when you sell it.  Seller financing, however, can offer significantly controlled risk.

You have certainly heard horror stories of people losing their life savings in the stock market, haven’t you? You have heard the stories about Bernie Madoff’s $65 billion scam and R. Allen Stanford’s alleged $7.2 billion fraud with investor’s money. But when you say this is a rare situation, you’re actually right. This is not very common.

At the same time, when we look at the data, there really is not a high rate of seller-financed loans going into default, either. There aren’t official recording requirements for this type of data, but from our company’s research, we have found that when adequate protective measures are put in place, details we prepare for all of our clients, the default rate is actually very low because with every one of these measures acts to control the risk.

When we include all the sellers that haphazardly went about finding and monitoring their buyers, far more in number and percentage of those that finance their business versus those that invest in the stock market get paid their investment back – plus a healthy return.

Just as you approach everything else with wisdom and care, evaluate the option of seller financing, not from a position of FEAR, but of opportunity. Collect sound knowledge and understanding of how to protect this investment and I know you are likely to find strategic use of seller financing will be a tool to optimize the return on your business investment.

Either trying to sell a small business or a mid-size business using factual information is important tool when trying to sell a business. In Dallas Sigma Mergers & Acquisitions helps both small and midsize business owners sell their business.

Five ways to Guarantee payment when financing the sell of your business

One of the top reasons that business sellers don’t want to consider seller financing as part of the sale package of their business is the myth that with seller financing, there is no guarantee they will get their money back. Actually, there are five guarantees you will get paid, one of which will be discussed here and the rest in later articles.

First, let’s put the fear into its proper context.  You aren’t going to stuff the sale proceeds from your business under your mattress or in a safe deposit box. At least I don’t think that is your plan. You are going to place that money into some other investment, somewhere other than the business that you have been running from day-to-day for the years you were creating and building it. Wherever you put your money (even if you opt for the mattress plan), there will be some level of risk. After all the house may catch on fire….. How about a personal guarantee on YOUR financial investment?  Wouldn’t that be nice?  Someone else personally guaranteeing that you will make a profit on your investment (the loan amount plus interest). 

Unfortunately, your financial planner does not sign a personal guarantee ensuring your retirement funds will never lose value. Neither does your realtor sign a personal guarantee that you’ll never lose 10%, 20% or even 50% of your house’s value. Before you start thinking that personal guarantees are something out of the long-distant past, unavailable to protect your financial future, think again. When you sell your business, the business purchaser does exactly that. It is routine and expected that the business purchaser “sign their life away” to you with a personal guarantee of payment as a condition of seller financing. (Yes,to be fair on Mid-Market business sales we sometimes do not see a personal guarantee… We will discuss this later )

That’s right, on the sell of small businesses the purchaser agrees to personally guarantee the loan. Now, if you really stop to think about the fact that you are taking a piece of your retirement or investment future and placing it in someone’s hands, isn’t it somewhat comforting to know that the buyer has some skin in the game as well? Literally, a personal guarantee can be written in a way the buyer could lose everything if this venture doesn’t work. That is kind of like what you did when you started – or bought – this business.

The best way to approach the selling of your business is to think of it in terms no less important than you did when you started the business in the first place. Many sellers are so excited about the prospects of retirement, the good life, less stress, etc. that they lose sight of the finish line in the last few minutes of the marathon.

Take this one last opportunity, this one big push, and summon the energy to really, really think this all the way through. Think of how ingenious, gutsy, resourceful and downright crafty you were getting the financing to start your company. Now apply all that to selling your business and you could just see a bigger return than you imagined. Don’t settle for a 5% to 10% investment on this golden opportunity when you can reap up to 25%, 30% or even 40% instead.

Personal guarantee of the portion of the sale price that is seller financed is the first step towards letting you sleep better at night. There are four more guarantees also: (1) stock pledges; (2) a lien against all business assets; (3) covenants governing what the new owner (the buyer) can and cannot do in terms of operation of the company; and (4) term life or disability insurance covering those possible life events.

Seller financing of a portion of your business sale price is one of the best investments you can make in terms of transparency of its progress, and guarantees of getting paid. Get educated on all of its details, and include these five guarantees in the deal when you sell your business.

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Dallas Business Broker, Mergers & Acquisitions Dallas / Fort Worth / Texas

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