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🛠️ Seller Financing (and Why It Works)

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Welcome to the Nuts & Bolts 10 week mini series...

For the next 12 weeks, we'll take a closer look at deal points involved in acquisitions of SMBs. They will cover misinterpreted deal terms, often misunderstood, underused, or uncommon components.

Watch for it on Tuesday mornings!

Getting The Seller to Be Your Bank (Without Making It Weird)

I'm a huge fan of seller financing.

Sometimes the best financing doesn't come from PE firms or banks - it comes from the person who built the business you want to buy.

As a buyer, here's what you care about: Getting the best possible deal without bleeding your cash reserves dry and having some runway to actually grow the business.

There's no hard and fast rule to the amount - it's all negotiable. Typically it ranges from 5-20% of the purchase price and carries an interest rate between 6-12% for 2-7 years and is usually subordinate to bank debt (this is huge).

Sitting across from someone who built a business over 20 years suggesting they accept an IOU for part of their life's work can feel a bit like asking your date to spot you dinner because you "forgot your wallet."

Awkward? Can be.

But here's why it works...

For Buyers:

  • Lower blended cost of capital than pure bank debt.
  • More flexible terms than institutional financing.
  • Can bridge valuation gaps when buyer and seller disagree on potential.
  • Strong signal of seller confidence in future performance.
  • Better prepayment terms than bank debt.
  • Reduces immediate cash needs, letting you preserve capital.
  • Fewer covenants than bank financing.

For Sellers:

  • Higher interest rate than market investments (typically 6-12% depending on risk).
  • Can eventually be a higher total purchase price.
  • Tax advantages - spreading gains over multiple years.
  • Keeps you aligned with success without operational headaches.
  • Can make your business more marketable to a broader buyer pool.
  • Maintains some control/oversight during transition.
  • Better than an earnout - you're getting paid on financial metrics you can verify, not operational ones you can't control.

So, when do you bring it up?

Early discussions about seller financing can kill momentum if handled poorly.

Wait until you have established rapport, and have a good understanding the business. Then, you can open the door and ask how flexible they are on deal structure.

Start to get specific around initial LOI discussions and frame it around mutual benefits:

"We're thinking about ways to structure this that could work better for both of us..."

When it comes to papering up the LOI, all the specific terms - interest rate, payment schedule, and security arrangements will be outlined.

Terms to nail down, and get right...

  • Interest rate
  • Payment schedule (monthly, quarterly, balloon?)
  • Default provisions
  • Security/collateral
  • Subordination to bank debt
  • Prepayment rights
  • Information rights
  • Cure periods
  • Personal guarantees (if buying through an entity)

When it's NOT going to work and both sides should run...

For Buyers:

  • Seller wants out completely - no ongoing ties.
  • Business cash flow barely covers proposed payments.
  • You're using it because no other financing source will touch the deal. (In this case - do some soul searching).

For Sellers:

  • Buyer has no skin in the game - all financed.
  • Buyer can't articulate clear growth plan.
  • Too much other debt in the structure.
  • Buyer resists personal guarantees.

Quick Case Study: How Seller Financing Saved a Deal

A packaging company was doing $12M revenue with $2.2M EBITDA. Owner wanted $8.8M (4x). Buyer had $800K cash and $4M SBA approval.

The $4M gap could have killed the deal right there, but instead, here's the structure they agreed to:

  • $4.8M at close ($800K equity + $4M SBA)
  • $2.5M seller note at 7%, 5 years
  • $1.5M earn-out
  • Seller kept 10% equity

When margins were compressed in Year 2, they hit trouble. But because the seller was still involved (and had skin in the game), they worked it out: deferred some payments, adjusted targets, and the seller helped land new customers. Win/win.

That's all for this week, thanks for reading.

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