The Best Strategies for Protecting Yourself when Offering Owner Financing
In todays market, seller financing plays a critical part in many deals; in the past few years its become the most common method of financing practice sales. As a potential seller, did chills just run down your spine? Everyone has heard horror stories of seller financing- and I’ve actually lived through one. So allow me to share with you some upsides of seller financing- yes, really!- as well as some critical ways to protect yourself.
Let’s start with the benefits. First off, when a seller agrees to finance a portion of the sale it puts the buyer and seller on more equal footing. By taking on some risk, the seller is essentially communicating confidence in the practice’s ability to function successfully under new ownership. This makes the buyer more comfortable, and- if additional loans are being procured from a financial institution- it also makes the bank more comfortable. Additionally, agreeing to finance all or part of the sale gives you a nice negotiating chip for a higher price. And seller financing can help a buyer pay more for a business; Banks and traditional funding sources have strict regulations on what they will finance (learn more in a future blog post!) so by kicking in additional funding the buyer can mitigate this.
But let’s not be naïve- if you agree to finance all or part of the sale, you are definitely taking on risk. I’ve lived through the legal battles that follow a default situation, and I want to save you from that hassle. Here are a few of the ways I structure these deals for my clients:
When you are considering owner financing, you need to act like a bank. Get credit reports, signed financial statements showing assets and financial obligations, and previous tax returns. Have a financial professional look everything over and evaluate the risk you are taking on. This helps you decide whether to finance to this person, and what terms are appropriate
“Interview” the potential buyer to evaluate their business background and experience
Consider establishing initial requirements for operating capital
Request financial and business references- and call them! Make sure this person is worthy of your trust.
Require the buyer to make a significant down payment. Don’t be the only one with a financial investment (and incentive to make it work)
Require regular financial statements and practice statistics as part of the contract, that way if a downward trend appears you can work together to fix the problem before it escalates to a non-payment situation
Consider strategic insurance purchases to cover death, disability- and to some extent, even default!
Just like a bank, you need to mitigate your risk and cover your bases in the case of unforeseen circumstances. Especially in light of recent economic conditions, the key here is don’t require perfection- buy look for patterns of financial responsibility.
Seller financing is complex, but if done right it’s a win-win scenario. Having an experienced team in your corner is crucial to getting it right, mitigating your risk, and enjoying a smooth sales process from start to finish. Let us know how we can help you- and share your seller financing experiences and questions in the comments below.