Buying a professional practice—medical, dental, veterinarian, law offices and accounting firms—can be a unique process, especially when the professionals who will succeed the current practice owners have high student debt and/or don’t have enough money for a down payment. In these cases, the seller will carry the bank loan and the buyer will make payments directly to the seller, which is called seller financing. The buyer pays the seller as agreed until the buyer is capable of holding the bank loan on their own.
The seller will sometimes set terms where the buyer must obtain financing other than seller financing after a set period of time, such as five years. That’s when a bank can step in and refinance the seller note, which essentially is the bank taking over the loan previously held by the owner.
Regardless of the financial strength of the buyer coming into the deal, after that person has demonstrated they can successfully run the business on their own through steady performance or growth for a period of time (typically around 24 months), then the bank will likely refinance the note. That’s one of the key reasons buyers need to connect with a bank early in the process.
Smart Business spoke with Karen Mullen, Vice President, Commercial Lending, First Federal Lakewood, about buying a practice and the role of seller financing in the process.
How is the value of a practice determined?
The practice is purchased based on an amount agreed upon by the buyer and seller and can be contingent on any number of variables. There are companies that specialize in practice valuations that apply their analysis to help the parties determine the price for the business.
Once a price is determined and the transaction is made, the purchase agreement is the legally binding document that gets taken to the bank.
When should the buyer of a practice get a bank involved?
The buyer should seek out a banking partner as early in the deal process as possible—the earlier the better—because through the banker, the buyer is enlisting their help to guide them through the process.
Ideally, the goal is to ultimately get a more traditional loan. Typically, if someone is selling a practice it’s because they want to get out, often completely, and don’t want to worry about whether they’ll receive payments each month for a practice they continue to own. So a banker can help set a timeline for the transition as well as the terms of or financial responsibilities around that transition.
All banks have different lending requirements. Some might want the seller to stay on as a consultant, some might not. So it’s good to get the bank involved at the beginning, even before the buyer starts paying the seller.
How important is it to properly value the business when refinancing through seller financing?
There’s a tendency by people who sell their practice to think their business is worth more than its actual value. That’s why business valuations are so important. They ensure buyers don’t start paying on a practice only to find out it’s worth far less than the purchase price. That’s also why the person buying the business should always request the tax returns of the practice they’re purchasing. It’s essential that a buyer see and review the financials before buying.
In addition to a banker getting involved early, when should other outside professionals get involved?
When purchasing a practice through seller financing, it’s important to have professional service providers on board early. That includes an attorney and CPA, as well as a banker, to outline the goals of the transaction prior to starting the process. Then, a timeline can be discussed as to when the buyer plans on taking over and when the previous owner will be completely out of the business. Knowing the end goal and engaging early with service professionals, as well as a banker, will greatly increase the chances of a successful transaction.
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