BPBG Blog #2

The Pros and Cons of Owner Financing When Selling Your Business

When it comes time to sell your business, one option that often flies under the radar is owner financing. This strategy involves the seller acting as the lender, allowing the buyer to make payments over time rather than securing a traditional bank loan or paying the full amount upfront. Owner financing can be a game-changer for both parties, offering unique benefits like tax advantages, flexible terms, and the potential for the seller to earn interest. However, it’s not without its risks. In this blog post, we’ll dive deep into the benefits and downsides of owner financing, explore how it can save you money on taxes, and explain how to secure the deal with a lien on the business while charging interest like a bank. By the end, you’ll have a clear understanding of whether owner financing is the right move for selling your business.

What is Owner Financing?

Owner financing, also known as seller financing, occurs when the seller of a business agrees to finance part or all of the purchase price for the buyer. Instead of the buyer paying the full amount at closing or securing a bank loan, they make regular payments (often monthly) to the seller over an agreed-upon period. These payments typically include principal and interest, much like a traditional loan.

For example, if you’re selling your business for $500,000, you might agree to finance $400,000, with the buyer paying $100,000 as a down payment. The buyer then pays you the remaining $400,000 plus interest over, say, five or ten years. To protect your interests, you can place a lien on the business, ensuring you retain legal claim to its assets until the loan is fully repaid.

Owner financing is particularly appealing in situations where buyers struggle to secure traditional financing or when sellers want to maximize their return on the sale. Let’s explore the benefits first.

Benefits of Owner Financing a Business

1. Attract More Buyers

One of the biggest advantages of owner financing is that it broadens the pool of potential buyers. Many aspiring entrepreneurs or small business owners may not qualify for a bank loan due to strict lending criteria, limited credit history, or insufficient collateral. By offering owner financing, you make your business more accessible to buyers who might otherwise be unable to purchase it.

This is especially true for small businesses, where bank loans can be hard to come by. Offering flexible terms can make your business stand out in a competitive market, potentially leading to a quicker sale.

2. Earn Interest on the Loan

When you finance the sale, you’re not just getting the sale price—you’re also earning interest on the loan, much like a bank would. Depending on the terms you negotiate, this interest can significantly boost your overall return. For instance, if you finance $400,000 at a 6% interest rate over 10 years, you could earn tens of thousands of dollars in interest on top of the principal.

The interest rate you charge will depend on market conditions, the buyer’s creditworthiness, and the risk level of the deal. Typically, owner-financed loans carry higher interest rates than bank loans because they’re riskier for the seller. Rates often range from 5% to 10%, but you can negotiate based on what makes sense for both parties.

3. Tax Advantages

Owner financing can provide significant tax benefits for the seller. When you sell a business outright for a lump sum, you may face a hefty capital gains tax bill in the year of the sale. However, with owner financing, the sale price is paid over time, spreading out the taxable income across multiple years.

For example, if you sell your business for $500,000 and your cost basis (what you originally paid or invested) is $200,000, your capital gain is $300,000. In a lump-sum sale, you’d owe capital gains tax on the entire $300,000 in one year, potentially pushing you into a higher tax bracket. With owner financing, you only pay taxes on the principal payments received each year, which can keep you in a lower tax bracket and reduce your overall tax liability.

Additionally, the interest you earn is taxed as ordinary income, but this too is spread out over the life of the loan. Always consult a tax professional to ensure you’re maximizing these benefits, as tax laws can be complex and vary by jurisdiction.

4. Faster Sale and Flexible Terms

Owner financing can speed up the sale process. Traditional bank loans often involve lengthy approval processes, appraisals, and negotiations. By bypassing the bank, you and the buyer can agree on terms that work for both of you, potentially closing the deal faster.

You also have the flexibility to customize the loan terms. For instance, you can offer a lower down payment, adjust the repayment period, or even include a balloon payment (a large final payment after a series of smaller ones). This flexibility can make the deal more attractive to buyers while ensuring you get the financial outcome you’re aiming for.

5. Retain Control Until Paid

By placing a lien on the business, you maintain a level of control until the loan is fully repaid. A lien is a legal claim on the business’s assets, meaning that if the buyer defaults on payments, you can seize those assets to recoup your losses. This security reduces the risk of financing the sale and gives you peace of mind that you’re protected.

How to Secure the Loan with a Lien

To protect yourself when offering owner financing, it’s critical to secure the loan properly. Here’s how you can do it:

1. Draft a Promissory Note: This is a legal document outlining the loan terms, including the principal amount, interest rate, repayment schedule, and consequences of default. It serves as evidence of the debt and is enforceable in court.
2. Place a Lien on the Business: A lien gives you a legal claim to the business’s assets (e.g., equipment, inventory, or intellectual property) until the loan is paid off. To do this, file a Uniform Commercial Code (UCC) financing statement with your state’s Secretary of State office. This publicly records your interest in the business’s assets and ensures you have priority over other creditors if the buyer defaults.
3. Require Collateral: In addition to the lien, you can require the buyer to pledge other assets as collateral, such as real estate or personal property. This provides an extra layer of security.
4. Include Default Provisions: Your agreement should clearly state what happens if the buyer misses payments. For example, you might have the right to repossess the business, accelerate the loan (demand immediate repayment of the full balance), or pursue legal action.
5. Work with Professionals: Hire an attorney and accountant to ensure all documents are legally sound and that you’re complying with state and federal regulations. A poorly structured deal can leave you vulnerable to losses.

Downsides of Owner Financing

While owner financing has many benefits, it’s not without risks. Here are the key downsides to consider:

1. Risk of Buyer Default

The biggest risk is that the buyer stops making payments. If this happens, you may need to foreclose on the business, which can be time-consuming and costly. Even with a lien, recovering your money isn’t guaranteed, especially if the business’s value has declined or its assets are insufficient to cover the outstanding balance.

To mitigate this risk, thoroughly vet the buyer’s financial background, credit history, and business experience. You might also require a larger down payment to reduce the loan amount and ensure the buyer has skin in the game.

2. Delayed Full Payment

With owner financing, you won’t receive the full sale price upfront. If you need immediate cash—for example, to fund retirement or another venture—this could be a major drawback. You’ll need to be comfortable waiting years to collect the full amount, plus interest.

3. Ongoing Involvement

Owner financing often means staying involved with the business longer than you’d like. If the buyer struggles to make payments or mismanages the business, you may need to step in to protect your investment. This can be stressful and time-consuming, especially if you were hoping for a clean break after the sale.

4. Legal and Administrative Costs

Structuring an owner-financed deal requires legal and financial expertise, which comes at a cost. You’ll need to pay for drafting contracts, filing liens, and possibly hiring a loan servicer to manage payments. These expenses can eat into your profits.

5. Interest Rate Risk

If you offer a fixed interest rate and market rates rise significantly, you could end up earning less than you would have by investing the sale proceeds elsewhere. Conversely, if rates fall, the buyer might refinance with a bank to get a lower rate, potentially leaving you with a lump sum that’s harder to reinvest profitably.

Charging Interest Like a Bank

One of the most appealing aspects of owner financing is the ability to charge interest, just like a bank. Here’s how to approach it:

• Set a Competitive Rate: Research current market rates for similar loans. Small business loans often carry higher rates than mortgages, so 5% to 10% is common for owner-financed deals. Ensure the rate reflects the risk you’re taking.
• Amortize the Loan: Use an amortization schedule to calculate monthly payments that include both principal and interest. Online calculators or financial software can help you create this schedule.
• Negotiate Terms: Be open to adjusting the interest rate or repayment period to make the deal attractive to the buyer while ensuring you earn a fair return.
• Include a Prepayment Clause: Decide whether you’ll allow the buyer to pay off the loan early and, if so, whether you’ll charge a prepayment penalty. This protects you from losing interest income if the buyer refinances or pays off the loan ahead of schedule.

Is Owner Financing Right for You?

Owner financing can be a powerful tool for selling your business, offering benefits like a larger buyer pool, tax savings, and the chance to earn interest. By securing the loan with a lien and carefully vetting the buyer, you can minimize risks and maximize your return. However, it’s not a one-size-fits-all solution. The potential for buyer default, delayed payment, and ongoing involvement means you’ll need to weigh the pros and cons carefully.

Before proceeding, consult with a business broker, attorney, and accountant to ensure the deal is structured properly and aligns with your financial goals. If done right, owner financing can be a win-win, helping you sell your business on favorable terms while providing the buyer with an affordable path to ownership.

If you’re considering selling your business and want expert guidance, contact Bridgepoint Business Group to explore your options and make the most of your sale.

Mike DeVault 
Principle Broker/Owner
BridgePoint Business Group