Acquisition Financing vs. Seller Financing: Which Works Best for Buyers?

Acquisition Financing provided by a cash flow lender fuels M&A activity especially for founder-owned companies. These deals are distinct from private equity-led buyouts where ownership is changing hands. Acquisition financing is widely available for businesses that are growing and taking a major strategic acquisition step.

Role of Seller Financing in Purchase Price Negotiation

Seller financing figures into the purchase price negotiation with the seller, to reduce the amount of cash the buyer must raise. It is usually a minor percentage of the total purchase price ranging from 5% to 20% and is dictated by overall competitiveness for the deal and the motivation of the seller.

Risks of Overusing Seller Financing

Often buyers try to overuse seller financing to reduce the amount of acquisition financing needed from a lender. While it is smart to use seller financing, there is a point where too much seller financing works against the buyer and creates an unfinanceable structure for the lender. For example, if the buyer wants the seller to hold 50% of the purchase price in seller financing, the seller is being asked to play the role of a lender to the deal and often starts thinking like a lender.

Seller Requirements When Financing Is High

This means the seller will start asking for current principal payments as opposed to balloon maturity like most seller notes. They will also ask for security in the form of collateral and maybe even personal guarantees from the buyer. While the buyer may agree to these things, it creates an unworkable structure for the lender. The acquisition financing lender will not allow the principal to be repaid ahead of their principal not will they allow the seller to have collateral in the form of liens on assets.

Adverse Selection Concerns

Additionally, too much seller financing raises an adverse selection issue in the mind of the lender. When most sellers give 10% to 15% in seller financing to their buyers, what does it say about this deal when the seller is giving 50%?

Complementary Use of Seller and Acquisition Financing

The best way to reconcile acquisition financing and seller financing is to use the latter in a complementary way. They work extremely well hand in hand structuring a purchase price and balancing the respective interests of the buyer, seller and acquisition financing lender.

Benefits for Buyer, Seller, and Lender

The buyer can use the seller financing as equity in the eyes of the lender, if it is properly structured and subordinated. The seller gets a long-term interest-bearing security and defers taxes on this portion of the sales price. The lender gains comfort from seeing the seller leave some skin in the game. It is a win-win-win for all parties but it is particularly valuable for the buyer who must raise less cash to get the deal done.