Seller financing when buying a business with no money down: three things to know

Are you looking to buy a business with no money down? Seller financing is the usual route, and there are three things you need to know about it before you approach a seller: how to propose it, how to protect yourself if the business underperforms, and what to put in the sale and purchase agreement. This guide covers each of them from a buyer's point of view.

What is seller financing?

Seller financing is when the seller of a business grants, in effect, a loan to the buyer to buy that business. Instead of the buyer paying the full price on completion, part of the price is deferred and paid later. Typically the buyer then uses the money generated by the business they have just acquired to pay the seller back over time.

If you are looking to use seller financing when buying a business, speak to the seller about it as soon as possible. A seller who learns late in the process that you are not paying the full price up front may walk away, or the deal may need to be restructured. Raising it early helps avoid delays and unnecessary costs. For a fuller explanation of the mechanics, see seller financing to buy a business.

How to propose seller financing

Say you have identified a business. How do you then propose seller financing to the seller?

In theory, anyone can be a buyer of a business if they make use of seller financing, because the money comes from the business itself rather than from the buyer's pocket. That is precisely the problem from the seller's side. They need to be convinced that you are a serious buyer and not simply someone with no money making an offer.

The way to deal with that is to have your proposal professionally drafted as heads of terms. Heads of terms set out the main points of the deal, including the price, how much is paid on completion, how the balance is deferred and over what period. Presenting them in a professional form communicates to the seller that you are serious, and it gives both sides a clear document to negotiate from. I explain how to use this document in heads of terms when buying a business.

Linking deferred payments to profits

Say the heads of terms have been signed and the seller is agreeable to seller financing. Because there will be deferred payments, made after the business has been bought, as a corporate lawyer I would advise you to consider making the amount you pay to the seller dependent on the financial performance of the business.

This can be done, for example, via an EBIT threshold. If the business achieves a certain level of earnings, the deferred payment is made in full. If it falls short, the payment is reduced. The logic is simple: you are paying for the business out of what the business earns, so the payment should move with those earnings. It protects you if the business does not perform as the seller said it would, and it keeps the seller's interests aligned with yours.

Accounting schedule in the SPA

If the deferred payments depend on the financial performance of the business, then the way that performance is measured becomes critical. Two accountants can look at the same business and produce different profit figures depending on how they treat particular items.

So as a corporate solicitor I would advise including a schedule in the sale and purchase agreement that details exactly how the financial accounts are to be prepared for the purpose of calculating the deferred payments. That avoids disputes later about how the calculations have been made, which is exactly where a performance-based deal can go wrong if the SPA is silent.

Post-completion restrictions on the seller

As a bonus tip, I would always advise my clients, if they are the buyers of a business, to include post-completion restrictions on the seller.

The concern is this. The seller has long-established relationships with the business's clients and suppliers. After they have sold the business to you, you want to make sure they do not use those relationships to pull clients and suppliers away from you. Restrictions in the SPA, for example on competing with the business or soliciting its customers and suppliers for a period after completion, are how you protect what you have paid for. When you are paying the seller out of the business's future earnings, protecting those earnings matters even more.

Next steps

Raise seller financing with the seller at the first opportunity and have heads of terms professionally drafted before you present your offer. Then make sure your corporate solicitor builds the EBIT threshold, the accounting schedule and the post-completion restrictions into the SPA. If you want to understand how to prepare before approaching a seller at all, read preparing to buy a business with no money up front.