How to Structure Seller Financing When Buying a Franchise

How do I structure seller financing when purchasing a franchise? It's a question worth asking when a buyer wants to acquire an existing location but doesn't have enough financing to cover the seller's asking price. Rather than abandon the deal, the buyer and seller may agree to spread part of the purchase price over several years.

On an episode of the “Lords of Lending” podcast, Abby Shemesh, head of acquisitions at Seller Edge Capital, discussed how seller notes work and what buyers and sellers should consider before signing an agreement.

Seller financing basics

Seller financing typically involves a down payment, an agreed-upon interest rate and regular payments on the remaining balance. Buyers and sellers also need to decide how long repayment will take and whether a larger balloon payment will be due at the end.

Shemesh said investors who purchase existing seller notes generally prefer shorter repayment periods.

"Ideally, most investors, both private and institutional, like to be in and out of an investment within the first three to five years," Shemesh said. “We see loans that have a 10-year amortization. I've got one right now that has a 240-month amortization on a business. So, yes, we see all flavors, but three to five years is ideal. We may be able to go up to six if all the stars align.”

Franchise buyers need to make sure the location earns enough to cover the monthly payments. On the seller's side, it's a matter of deciding how long they're willing to wait for their money and whether the buyer can keep up with payments.

Contract provisions

The promissory note and purchase agreement should explain what happens if payments stop or financial problems arise. Shemesh identified three provisions he looks for when evaluating seller notes.

"No offset language or very little offset language in the contracts, both in the asset purchase agreement or the promissory note; personal guarantee if it's an entity; and number three, language in the asset purchase agreement or promissory note that allows the seller to request anywhere between one and four times a year, preferably two to four times a year, financials of a borrower," Shemesh said.

If the purchasing company defaults, a personal guarantee may allow the seller to hold the buyer personally responsible for repayment. Regular financial reports also help sellers see how the business is performing while they're still owed money.

Offset provisions also matter. These clauses may allow buyers to reduce or withhold payments if they discover unpaid obligations from the previous owner. Shemesh gave an example involving a $20,000 vendor debt discovered after a sale. If the buyer owes the seller $5,000 a month, an unrestricted offset could result in four months without payments.

"From an underwriting perspective, that's a nonperforming loan," Shemesh said. "Offset or not, that is a deal killer, plain and simple."

Sellers who finance an acquisition don't necessarily have to collect payments until the loan is paid off. Some investors purchase existing seller notes at a discount, giving sellers access to a lump sum sooner.

Investors may purchase the entire note or only part of the remaining payment stream. The terms, payment history and business performance can influence whether a note attracts interest.

Franchise buyers should also account for franchisor approval requirements, transfer fees and any training obligations before finalizing the acquisition.

Structuring the deal

When deciding how to structure seller financing, buyers and sellers should take three steps:

• Review the numbers. Determine what the business can realistically afford in monthly payments.

• Have an attorney review the agreement. Address personal guarantees, financial reporting and offset provisions before closing.

• Discuss future financing options. Ask lenders whether refinancing may be possible and confirm any franchisor requirements that could affect the deal.

Seller financing can help make a franchise acquisition possible, but a workable agreement starts with terms both parties understand and can reasonably meet.