Using Seller Financing to Buy an Online Business
Did you know that digital assets are one of the best-performing investments? We’ve seen it first-hand with savvy individuals snapping up solid online businesses on our marketplace and then selling them after a few years for outstanding ROIs.
Digital assets may give great ROI, but as an emerging asset class, it has historically been difficult to secure financing for purchases, although this is changing rapidly.
This precious lack of financing options has put both buyers and sellers at a disadvantage. So, what should forward-thinking entrepreneurs do?
One option that has always been open to both parties is seller financing.
But what exactly is seller financing? How does it work? What are its pros and cons? And does it make sense for every business?
Let’s take a closer look.
What Is Seller Financing?
In a nutshell, seller financing is owner financing. Once a purchase price is agreed upon, the seller receives a percentage of the purchase price upfront, and the buyer essentially becomes the borrower while the seller becomes the “lender” of the remaining capital.
The remaining funds are received through either an additional lump sum at a later date or installment payments over a period of time to cover the full cost of the purchase.
It’s one of the most common deal structures we see on our marketplace, along with performance-based earnouts and stability payments.
To see how it works, let’s take an example of a buyer and seller who have agreed to a $700K purchase price for an Amazon FBA business.
The buyer might pay $500K upfront, followed by 10 monthly payments of $20K each.
The seller gets the full amount within 10 months, and the buyer doesn’t have to put all available capital upfront at the start.
What Are the Alternatives to Seller Financing?
Of course, seller financing isn’t the only path to securing a small business, even one that solely has digital assets.
You could look into financing through HELOCs, 401Ks, or even personal loans or gifts from friends and family.
There is also an increasing number of financial providers that are willing to offer funding for online businesses. Some lend to cover inventory costs, and others are willing to apply funding to any part of the purchase.
However, going this route could mean that your buying power is reduced.
There could be restrictions on the types of businesses you can purchase with other forms of funding, and red tape could cause you to miss out on the deals that you want.
Benefits of Seller Financing
Like any type of financing, seller financing for small businesses can come with risks. However, it can also come with enormous benefits.
This holds true for both buyers and sellers.
Let’s take a look at some of the benefits of this form of financing for both sides.
The primary benefit for sellers being open to financing part of the purchase is that it can widen their buyer pools.
It can also be a negotiation lever to help sellers get more money for their businesses compared with dealing solely with cash-upfront buyers.
There are tax advantages to seller financing as well. We’ve actually had sellers who prefer deal structures with seller financing or earnouts because it helps them mitigate the huge capital gains taxes that can come with taking lump-sum payments.
For competitive markets, like we often see with high-quality Amazon FBA businesses, some buyers leverage seller financing by offering performance-based earnouts.
This can be particularly attractive for sellers, because we’ve seen cases first-hand on our marketplace where taking a performance-based earnout increased the final sales price beyond the initial listing price.
For example, we had a seller who listed a well-developed Amazon FBA business on our marketplace with an asking price of $754K. Within days, the seller was flooded with interest from potential buyers, which sparked fierce competition for the well-run business.
To make their offer more attractive, the eventual buyers offered more money through an earnout based on year-on-year growth.
On the buy side, using seller financing allows you to purchase a business faster compared with conventional financing options. You don’t have to provide your credit score or put up collateral, meaning you can get the deal done quickly.
It also provides room for better negotiations and terms. As a buyer, you could end up with more favorable loan terms with seller financing compared with the traditional financing route.
If you were to go through a lending institution, you’d have to pay a higher interest rate. You might also have to put up personal assets or guarantees, which exposes you to higher risk.
One of the biggest advantages for buyers, however, is that this type of financing allows you access to greater cash flow for growing the business right away without having to explore options for raising additional capital, such as applying for business loans.
What Does Seller Financing Look Like on Our Marketplace?
Knowing the benefits of seller financing for both parties is great, but is it used in the real world?
Looking at our marketplace, cash upfront remains the most popular option for small business sales. But we’ve also seen our fair share of deal structures.
In 2020, we sold 297 businesses. Of those, 66 had some sort of deal structure in place, with the average upfront price representing 73% of the total purchase price.
Things evolved slightly the following year. In 2021, we sold a whopping 335 businesses! It was also the year we sold our first eight-figure business.
In fact, the market was so hot, we even dubbed it The Season of the Seller.
But amidst an increase in sales and average sales prices, as well as rising multiples, only 56% of the sales on our marketplace involved some sort of a deal structure.
The following table shows the breakdown of the action we saw last year:
As you can see, it’s rare to find deals below $100K with a deal structure. The sellers in this tier may be willing to negotiate the sales price, but they prefer to have all cash upfront.
Deal structures become more common the higher a business is priced. They’re most likely to happen on seven-figure-and-up deals. If we look at the three tiers below $1M, we see that all of them combined just barely equal the number of deal structures found at seven figures and up.
Is Seller Financing Right for You?
As you’ve seen, seller financing can provide benefits to both the buyer and seller, and it works for certain businesses. But before jumping into a deal with seller financing, you need to decide if it makes sense for you.
Let’s take a look at some of the risks involved with seller financing, as well as what makes a potentially good candidate for this type of deal structure.
Understanding the Risks
Although seller financing is a great way for sellers to unload digital assets quickly and for buyers to find a wider range of business acquisition targets, it’s not risk-free.
With this kind of financing arrangement, the seller assumes nearly all the risk.
The most obvious downside for a seller is that not only are they accepting a smaller portion of the purchase price upfront but there’s also no guarantee that they’ll receive the rest of the funds.
During the financing period, even though the seller has a vested interest in the business, they have little to no control over how it’s run. If earnings decline under the new business owner, there’s a possibility that the buyer defaults on the remaining payments.
On the flip side, as a buyer, if you’ve agreed to installment payments, you’re on the hook for repayments even if the business declines. That’s why conducting due diligence before any business purchase is essential.
You’ll also have to accept that even though you’re the new owner, the seller might continue to be involved in the business in some capacity until all funds have been paid.
To mitigate some of the risk for both sides, you’ll have to organize repayments and asset transfers ahead of time.
You’ll need a solid plan in place, which might involve using an escrow service or a third party to hold funds and/or assets until the end of the financing terms.
Showing You’re the Right Buyer
Now that you understand more about the process and the risks involved, how do you show a seller that you’re a solid candidate for financing?
Show off your business history. Do you have solid experience in the field? If not, do you have other demonstrable work experience that can put the seller’s mind at ease?
Put together a serious business plan. Show the seller exactly how you plan to grow the business. If the seller has feedback, it’s good to take that into consideration. After all, they know their business better than anyone.
Be flexible with your terms. If you’re empathetic to the seller’s risks and flexible with the repayment terms, you’re more likely to have your offer accepted.
Be serious about your upfront payment. Depending on the value of the business, you need to be prepared to offer a down payment of around 75% of the purchase price, according to our market data.
How Can You Increase Your Chances of a Successful Transaction?
If you want to use seller financing to fund the purchase of a small business, it helps to have seasoned professionals on your side to guide you through the process.
Working with a business broker can simplify the process for both sides.
Working with someone who knows both the space and common deal structures can help you create an offer that is more likely to get accepted.
We facilitate communication between both parties so that everyone feels comfortable with the terms of the deal laid out in the promissory note.
In addition, when you buy or sell a business through us using seller financing or another common deal structure, we guide you through until the very end. We’ll help you with repayments and reconciliations and make sure that all parties stay in contact.
As an added benefit, we’ll hold the assets until the loan is repaid so that neither party feels like they are at a disadvantage. This extra layer of protection can be used as additional leverage when you’re pitching your offer.
If you’re interested in learning more about buying a business using seller financing, schedule a call with one of our advisors today.