SELLER FINANCING: WHAT YOU NEED TO KNOW

 Seller Financing Graphic Alternate 960x630

The Lender of Last Resort

Trying to sell or buy a business or commercial real estate? If you are the biggest obstacle you will encounter is financing. Tough new rules govern bank lending in the wake of the 2008 economic collapse. Banks face greater government scrutiny than ever before and have become more restrictive in giving loans. Further, the documentation requirements and due diligence banks must perform to issue a loan have increased significantly.

 

These facts of life frustrate people trying to buy or sell a business or commercial real estate. There are very few cash deals out there. This is why I am seeing more and more so-called 'seller financing' transactions.

 

Seller financing is the last resort when banks either refuse to give a loan for a particular transaction or don't agree to finance the full sale price. The seller holds paper and acts like a bank.

 

 

Risk to the Seller

From the point of view of sellers this type of financing is risky business. Banks manage the risk of their many loans, insure against uncollectible loans, and have the economic strength to absorb losses if and when they occur. Banks benefit from the law of large numbers. Not so with an individual seller who agrees to finance a single loan.

 

I tell all my clients who consider seller financing to evaluate risk. Who is the buyer and what is his credit worthiness? Be aware and beware of the reputation of the buyer (which you can check out for free on so-called reputation score websites like Mylife.com.) What if the buyer has a good credit score, good collateral and a bad character?

 

 

Risk to the Buyer

Buyers face risk too. What if the seller has a great property and a lousy character? (Again, check the person out on a free reputation score website such as Mylife.com.) As a CPA experienced in advanced valuation concepts I could discuss this problem in great technical detail. But here is the bottom line in plain English:

 

Good property in dirty hands is worth less money

 

It doesn't matter if the seller has a great property, you really want it, and he's willing to give you seller financing. If the seller has a police record and a long history of being sued by victims he tried to cheat then any property he sells you is worth less money because you don't know what you don't know. Are there undisclosed environmental liabilities? Asbestos? Hidden explosives? Did the seller bury some of his victims there?

 

Knowledge is power because it helps us avoid risk.

 

 

What Rate to Charge?

When it comes to interest sellers should charge a significantly higher rate because of the risk they are exposing themselves to. Banks, because they are big and financially sophisticated, can charge market interest rates for a transaction. Private sellers on the other hand must charge much more. When clients ask me what rate they should charge on a seller financed transaction I always say "double digit." Always charge at least 10% or more based on the details of the transaction. If you are not a bank but act like a bank then you must think like a bank: The interest rate charged for a seller financed deal must be based on risk.

 

 

You Must Charge Interest

I've seen seller financed transactions where both parties want an interest free deal. The IRS does not allow this if the total loan amount exceeds $10,000. You must charge at least the minimum interest rate prescribed by the IRS. This minimum rate is called the "Applicable Federal Rate" ("AFR") and is updated monthly. There are actually three AFR's: (1) short term loans that are paid off in three years or less; (2) mid-term loans paid off in nine years but more than three years; (3) long term loans paid off over nine years.

 

Charging interest does not mean you must charge more. For example, assume a buyer and seller agree on a $100,000 sale price and are subsequently told by their accountant that they must charge interest. This surprises them and the buyer worries he will have to pay extra. THIS IS NOT TRUE.

 

In this simplified example the deal can be altered to comply with the IRS requirement to charge interest without increasing the total amount paid. This can be achieved by calculating what is called the imputed principal amount. A $100,000 deal with a ten year loan payment schedule that is closed in June, 2018 requires a minimum IRS interest rate of 3.02% (assuming monthly payments.) The imputed principal in this case is $86,218 and the total required interest is $13,782. The total amount paid remains locked at $100,000 (86218 + 13782 = 100000) and the IRS is happy.

 

 

Sellers: Protect Yourself

If you are the seller in a seller financed transaction and are selling real estate I recommend keeping the title until the buyer pays in full. This is a protective measure that offers the greatest degree of loan collateralization. However, as a buyer nears the end of paying a loan he may want the title prior to payoff. If the seller keeps the title until loan payoff the buyer and seller should agree on how to handle property insurance.

 

 

Buyer's: Beware of Prepayment Penalties

Buyers turn to seller financing usually because they can't obtain a traditional bank loan, or the bank won't lend enough to cover the sale price. As time goes by and a buyer pays down the loan he may become financially stronger while (perhaps) building equity in the property. A point may come when the buyer doesn't need a costly seller-financed deal and will want to refinance with a bank at a lower rate. Watch out for prepayment fees!

 

 

Banks Don't Lend on Intangible Assets

Because of tougher lending standards banks are generally not allowed to give loans collateralized by intangible assets. If you are trying to sell your business be aware that banks will not finance the buyer for goodwill. Goodwill is the financial value of a good business reputation and is usually built up over many years of taking good care of customers. The reason banks won't consider goodwill is because they can't physically seize it in case of default. If goodwill is a substantial portion of the sale price it is almost certainly the case that seller financing will be needed to bridge the gap between what a bank will lend and what a seller wants for his sales price.

 

 

LEGAL DISCLAIMER

George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339

©2015 Copyright George Adams CPA MBA. All Rights Reserved.

Business Cases:

Nucor Steel: Into the Storm

10-25-2011 Hits:3734 Company Analysis George Adams

Nucor Steel: Into the Storm

One of the largest steel companies in the U.S.had a forty year track record of unbroken profitability until 2009. How can Nucor succeed in a tougher, harsher climate?

Read more

RITZ-CARLTON (Circa 2008)

12-14-2011 Hits:4189 Company Analysis George Adams

RITZ-CARLTON (Circa 2008)

 The business strategy of luxury with a human face requires both popularity and exclusivity. How can Ritz-Carlton master this apparent contradiction?

Read more

SAS Company Analysis (Circa 1995)

12-13-2011 Hits:3715 Company Analysis George Adams

SAS Company Analysis (Circa 1995)

Does it pay to fly dirty?

Read more

Otis Elevator (Circa 2004)

12-13-2011 Hits:5083 Company Analysis George Adams

Otis Elevator (Circa 2004)

The largest elevator company in the world has to make some tough choices.

Read more

Vertex Company Analysis (Circa 2003)

12-27-2011 Hits:2957 Company Analysis George Adams

Vertex Company Analysis (Circa 2003)

Crucial business decisions can benefit from the insights of combinatoric analysis.

Read more

Walmart Company Analysis (Circa 2003)

12-27-2011 Hits:3116 Company Analysis George Adams

Walmart Company Analysis (Circa 2003)

The largest retailer in the world is getting too big to grow any further without new and better thinking.

Read more

Sara Lee Corporation (Circa 2008)

12-27-2011 Hits:3005 Company Analysis George Adams

Sara Lee Corporation (Circa 2008)

Nobody doesn’t like Sara Lee, until the company started hating itself.

Read more

Southwest Airlines (Circa 2010)

12-27-2011 Hits:3479 Company Analysis George Adams

Southwest Airlines (Circa 2010)

How can the most successful U.S. airline keep it up?

Read more

The Power to Save the World: Fusion, the Unknown Ideal

12-28-2012 Hits:4233 Company Analysis George Adams

The Power to Save the World: Fusion, the Unknown Ideal

Energy is the ultimate question of our time: how do we get it, at what cost and what consequences?

Read more

Business Issues:

SELLER FINANCING: WHAT YOU NEED TO KNOW

08-09-2018 Hits:567 Business Issue Analysis George Adams

SELLER FINANCING: WHAT YOU NEED TO KNOW

Trying to sell or buy a business or commercial real estate? If you are the biggest obstacle you will encounter is financing.

Read more

WHY THINGS GO WRONG

06-23-2018 Hits:432 Business Issue Analysis George Adams

WHY THINGS GO WRONG

 The supreme Enemy of Mankind is an equation.

Read more

WATCH YOUR MAIL

06-15-2018 Hits:432 Business Issue Analysis George Adams

WATCH YOUR MAIL

It is an unfortunate fact that many people and businesses treat administrative tasks like opening up mail as a nuisance. When people get busy with substantive work and the distracting events of life these seeming nuisance tasks get neglected, leading...

Read more

MEASURING EMPLOYEE WORTH

05-30-2018 Hits:482 Business Issue Analysis George Adams

MEASURING EMPLOYEE WORTH

The job market today is tough and highly competitive. The first concern of many employees is to just hold onto their job. Labor force mobility (workers quitting one job to begin another) is at an all-time low. But all workers...

Read more

SMART MID-YEAR TAX MOVES

05-30-2018 Hits:657 Business Issue Analysis Administrator

SMART MID-YEAR TAX MOVES

Mid-year and mid-summer arrive on schedule every June 30th or so. Here are some smart tax moves you should consider in order to avoid a nasty 'April surprise' next year:

Read more

PLANNING FOR THE UNEXPECTED

05-30-2018 Hits:452 Business Issue Analysis George Adams

PLANNING FOR THE UNEXPECTED

Anyone who owns anything of value needs three things to document their intentions and protect their interests. These three critical documents are a will, a durable power of attorney and a living trust.

Read more

MAINE OPPORTUNITY CREDIT

05-30-2018 Hits:1255 Business Issue Analysis George Adams

MAINE OPPORTUNITY CREDIT

One of the most generous and most overlooked Maine income tax credits is the so-called Credit for Educational Opportunity. In my experience few accountants and even fewer clients are aware of its existence. The credit is intended to reward college-educated...

Read more

UNUSUAL TAX RULES

05-30-2018 Hits:443 Business Issue Analysis George Adams

UNUSUAL TAX RULES

The tax law is a strange hybrid containing many obscure rules, exceptions to the exceptions, and deeply counter-intuitive definitions. Buried in the clutter of what Congress created is opportunity. Finding useful opportunities in the tax law is like digging through...

Read more

THE NEW TAX LAW

12-31-2017 Hits:5029 Business Issue Analysis George Adams

The 2017 Tax Cuts and Jobs Act was signed into law on December 22, 2017 and represents the most significant change in tax law since 1987.

Read more

IT'S TAX TIME AGAIN

02-02-2017 Hits:1948 Business Issue Analysis George Adams

IT'S TAX TIME AGAIN

The 2018 tax filing season opened on Monday, January 29th when the IRS began processing returns.

Read more

HOW TRUMP DID IT

11-09-2016 Hits:2238 Business Issue Analysis George Adams

HOW TRUMP DID IT

This article is strictly non-political and explains how the billionaire Donald Trump legally avoided income taxes for many years.

Read more

WHAT RECORDS SHOULD YOU GIVE YOUR ACCOUNTANT?

01-12-2017 Hits:2068 Business Issue Analysis George Adams

WHAT RECORDS SHOULD YOU GIVE YOUR ACCOUNTANT?

For many people it's not obvious what records and information their accountant needs. This article will discuss the most important information your accountant must know when it's time to do your taxes.

Read more

BEWARE OF DARK CARS

01-12-2017 Hits:1851 Business Issue Analysis George Adams

BEWARE OF DARK CARS

One phenomenon that began in the last few years in Central Maine is dark cars

Read more

YEAR END TAX PLANNING

11-29-2015 Hits:2840 Business Issue Analysis George Adams

YEAR END TAX PLANNING

Once more it’s time to play another deep game of chess with the IRS. Are you ready? The clock is ticking....

Read more

Why Are You Using An LLC?

05-20-2012 Hits:6854 Business Issue Analysis Administrator

Why Are You Using An LLC?

It can cost you a fortune if you choose the wrong entity for your business.

Read more

Pi and Pi Squared

10-31-2011 Hits:7121 Business Issue Analysis George Adams

Pi and Pi Squared

How can companies motivate innovation and manage internal conflict effectively?

Read more

Secret Unions: Employee Collusion and Conspiracy

10-25-2011 Hits:7044 Business Issue Analysis George Adams

Secret Unions: Employee Collusion and Conspiracy

Anyone can use Game Theory to try to get ahead. But sometimes there is a better, simpler strategy.

Read more

Jump! Employee Performance On Trial

10-31-2011 Hits:6572 Business Issue Analysis George Adams

Jump! Employee Performance On Trial

The true and the obvious frequently differ, especially when it comes to assessing employee performance.

Read more

You Have to Break Eggs to Make an Omelet

11-30-2011 Hits:6029 Business Issue Analysis George Adams

You Have to Break Eggs to Make an Omelet

Some employees take their work seriously while others don’t.

Read more

The Fallacy of Teamwork Part I: Train of Thought

11-30-2011 Hits:7320 Business Issue Analysis George Adams

The Fallacy of Teamwork Part I: Train of Thought

Is teamwork the answer to every business problem?

Read more

The Fallacy of Teamwork Part II: Michael Jordan Doesn’t Need a Memo

11-30-2011 Hits:8118 Business Issue Analysis George Adams

The Fallacy of Teamwork Part II: Michael Jordan Doesn’t Need a Memo

What does neuroscience have to say about the applicability of the team sports model to business collaboration?

Read more

On the Relative Importance of Sales People and Technical People to Business

11-30-2011 Hits:6531 Business Issue Analysis George Adams

On the Relative Importance of Sales People and Technical People to Business

Is it really true that technical employees are just a bunch of nerds a company puts up with so its star sales people can make big profits?

Read more

Business Cannot Ignore Its Environment

11-30-2011 Hits:6740 Business Issue Analysis George Adams

Business Cannot Ignore Its Environment

The power of goodwill to destroy the most successful companies.

Read more

Artificial Intelligence

11-30-2011 Hits:9137 Business Issue Analysis George Adams

Artificial Intelligence

There is nothing new under the sun, until computers become smarter than the smartest person.

Read more

The Growing Spectacle of Job Lotteries

11-30-2011 Hits:6499 Business Issue Analysis George Adams

The Growing Spectacle of Job Lotteries

A new take on the growing commodification of labor.

Read more

Understanding Tax Clients

06-05-2012 Hits:4380 Business Issue Analysis George Adams

Understanding Tax Clients

The primary cliché of our profession of taxes and accounting is that every client is different.

Read more

Making Business Succeed, Part One: Winning at Retail

06-26-2013 Hits:4654 Business Issue Analysis George Adams

Making Business Succeed, Part One: Winning at Retail

What you don't know may put you out of business.

Read more

Making Business Succeed, Part Two: Fresh Thinking For Farmers

07-23-2013 Hits:4059 Business Issue Analysis George Adams

Making Business Succeed, Part Two: Fresh Thinking For Farmers

There are many reasons for having faith in a seed.

Read more

Making Business Succeed, Part Three: Succeeding with Services

09-05-2013 Hits:6871 Business Issue Analysis George Adams

Making Business Succeed, Part Three: Succeeding with Services

Your journey to success will have many twists and turns. Here are important insights to guide you to success with your service business.

Read more

Making Business Succeed, Part Four: Victory for Vacationland

09-26-2013 Hits:4386 Business Issue Analysis George Adams

Making Business Succeed, Part Four: Victory for Vacationland

Tourism and related businesses dominate the economy of Vacationland.

Read more

Five Key Facts of Life for Non­‐Profits

08-14-2013 Hits:5251 Business Issue Analysis George Adams

Five Key Facts of Life for Non­‐Profits

You may be the last line of defense for your non-profit organization.

Read more

CLOUDY, WITH A CHANCE OF PAIN

07-30-2014 Hits:5116 Business Issue Analysis George Adams

CLOUDY, WITH A CHANCE OF PAIN

The truth about cloud-based accounting and the dangers of bundling.

Read more

TAX RETURN FRAUD IS RAMPANT

04-26-2015 Hits:3098 Business Issue Analysis George Adams

TAX RETURN FRAUD IS RAMPANT

According to a January 2015 news release from the IRS, for the period 2011 – 2014 the tax agency stopped 19 million suspicious tax returns and prevented the issuance of approximately $63 billion in phony refunds.

Read more

GEORGE'S POWER BREAKFAST

01-17-2016 Hits:5763 Business Issue Analysis George Adams

GEORGE'S POWER BREAKFAST

Business owners are the nucleus of their business, the center upon which everything else depends. It is frequently the case that business owners simply can't afford to get sick. Healthy food is the best preventative medicine of all.

Read more

GHOST ASSETS

10-26-2016 Hits:1990 Business Issue Analysis George Adams

GHOST ASSETS

Are You Being Haunted By Them? If You Are It’s Costing You Money

Read more

 

Contact Me

Member

Telephone: (207) 989-2700
Fax: 1-866-444-0032
Email - georgeadams@intelligenceforrent.com
Address: 450 South Main Street: The HQ of IQ
               Brewer Maine 04412-2339

Maine Society of Certified Public Accountants
Certified QuickBooks Professional Advisor
Bangor Region Chamber of Commerce
Beta Gamma Sigma and Phi Kappa Phi
National Association of Independent Writers and Editors
Published Contributing Writer-Maine Eagle Magazine
New England Peer Review

 

© 2018 Copyright George Adams CPA MBA. All Rights Reserved.
George Adams - More Than Just a CPASM

Real time web analytics, Heat map tracking