Seller financing a business sale for retirement – too risky?
When selling a business can be hard - and it may seem impossible at times - to find the right successor. This is your life’s work, right? It’s a delicate balance of skill, work ethic, moral character, and drive - and it all has to line up. Let’s say that lightning does strike and you find the right person – but there’s one little issue. They don’t have the cash to pony up as one lump sum and buy the business from you outright, and lending is not an option. Does it make sense to entertain seller financing? If so, how do you seller finance a business sale and not blow up your retirement?
Before we get started, we are financial advisors for business owners in New York and beyond. We publish blogs and videos about the market, retiring from your business, managaging the financial and tax responsibilities of being a business owner, etc. on our blog. Please follow us here.
And now, for the feature presentation!
What is seller financing?
Let’s start with a basic definition.
What exactly is seller financing?
Also called “owner financing”, seller financing is a way to buy a business by negotiating a deal with the business owner themselves rather than having to go through the bank.
Let’s supposed you own a small plumbing operation in your town for 35 years and you’re thinking about retiring from your business. You’ve got five employees who want to do what – plunge toilets! They have zero interest in taking over your business.
Your clients love what your company does.
Your employees love working there.
Wouldn’t be just awful for the business to end with your departure from it?
So you circle around in your network and voila – a promising buyer approaches you with interest. He’s an experienced plumber with excellent management skills and would be able to take over seamlessly. You agree to sell him the business for 2.5 times net income, or $950,000.
However, there’s one little (not so little) problem…
Denaro
Denari
Shekels
Dollars…
He just put down $400,000 to put his dream home for his wife and kids. His credit is tapped out by his mortgage, and his pockets are light when it comes to spending cash.
What do you do?
Here’s where seller financing comes into play. You talk with the buyer and create a promissory note that enables you to, essentially, lend the buyer the money to get the deal done. Typical scenarios may go like this:
- You could be compensated by a lump sum in the form of earnings. The buyer could potentially hand over a certain amount of profits from the business to pay off the note.
- You could create an agreement whereby a certain percentage, let’s say 15%, of the business’s net income is paid to you eight years.
Should I offer seller financing as a business exit strategy?
There are a few advantages to the owner of selling your business through owner financing.
- Terms can potentially be much less stringent than he would get from a bank. That is because you, the seller, are acting as the bank! Traditional lenders care about the buyer having assets to seize in case the loan isn’t paid, whereas you care more about keeping the business alive and wouldn’t want to compromise his financial health.
- It’s better than doing a deal with a private equity firm which will award you a check and then turn around and jack up prices for your clients after firing all your loyal employees.
- You are able to customize the terms of the deal based upon what makes sense for the owner, buyer, and the business.
- You may earn interest, if you structure the note that way.
There is also the risk that the buyer doesn’t pay you. You are essentially taking the risk the bank would have taken. You will be the party who has to foreclose on the business if the buyer defaults. The mental stress of having to prosecute and seize someone’s collateral (mortgage, personal assets, etc.) may also be undesirable (and not how you dreamed about exiting your business and starting retirement.)
What about my taxes?
Here is where it gets a bit tricky. We are not tax advisors, and nothing in this article should be interpreted as guidance specific to any one individual or situation. For such guidance, refer to your CPA.
But having said, here are some general guidelines.
If you chose to be paid in stallments, you may be able to spread out the tax impact of selling the business. In this case, the capital gains tax would be deferred to future years and recognized bit by bit each year, instead of being due all at once if you were to sell your business in a lump sum.
Will I pay income tax on the sale of my business?
Maybe, maybe not. It depends on how you set up the note. The tax implications of selling your business using owner financing can be pretty overwhelming; you don’t have to do it alone! As we’ve said before, we’re not tax advisors and the best thing you can do is consult with your CPA, tax advisor, and financial advisor at all points before, during, and after the sale.
Too much risk for your retirement?
If you are selling your business to retire, and are considering owner financing as a way to do it, you really need a clear vision of what retirement is going to look like. Do you still want to be contending with the ups and downs of running a business during your “Golden Years?” Or did you want to completely detach?
If you plan to sell your business through seller financing and then go retire, keep in mind that:
- You are essentially putting all your faith in the buyer’s ability to run the business successfully, as well as or even better than you.
- You are also betting on the hope that the employees and customers will remain after the new management takes over.
- There is much less protection. You are placing stock in the buyer’s integrity. If you were to do a deal through a bank and the buyer were to default, the bank is the one who has to take recourse. Not so in an owner-financed deal because in this case you would be the one left holding the bag, having to pursue the buyer legally and make yourself whole (instead of the bank making you whole).
How does a business owner retire, anyways?
All of this transaction talk is in the wake of a much bigger topic. What is the overall plan for your retirement?
- Do you have other sources of income than this business sale (rental properties, annuities, pension, investment portfolio)?
- Is there some reason you need all the money upfront, as a lump sum, or are you okay with taking it as an income stream?
- What are your retirement expenses going to be? Do you have large expenses that would require you to have a lot of cash of hand to ensure they are paid?
- Would you potentially need more than what the business sale could offer you in order to retire comfortably?
- What kind of overall financial condition are you in? When is it realistic to plan to retire, given that?
- What are your plans to afford medical care? Would it make sense to stay on as an employee of some sort so you can get access to health benefits through your business?
- What kind of tax shape are you in? Are there any tax liens on your home or other assets? Are you delinquent on taxes, or have you always paid on time?
- What do you plan to do with your free time in retirement? Would you miss being a part of your business? Is it realistic to see yourself content never working again or would you enjoy being a part of the business in some way, even after you retire?
This is a serious decision – get the right support!
Selling your business, through seller financing or otherwise, is a seriosu decision that has a deep and lasting impact on all aspects of your life, not just retirement. It’s prudent to get the right support. You should compile a team of professionals such as a CPA, lawyer, and financial advisor who have done this type of work before.
We are financial advisors for business owners and have helped many owners sell their businesses and retire. Contact us to set up a time to meet if you wish to discuss if seller financing a business is a good option for you given your overall retirement goals.
