Bank financing vs. Owner Financing (Dan Pena QLA, Company Acquisitions)

One of your premises is not correct.

Buying a business is similar to buying a house from the bank's perspective.

You make the purchase agreement, then you open a escrow account. The bank determines how much the asset is worth (in this case, the business). Using your example, if the bank thinks the business is worth $1 million, it would be willing to loan $600,000 ($1 million X 60%). Hopefully, it would allow you to use seller financing for the rest. This amounts to 100% financing which is considered very risky by many banks.

Once the bank agrees to lend you the money, you will not touch that money under most circumstances. The money will go into the escrow to pay the seller. The business then becomes the collateral for the loan.

There may be other ways to handle this, but generally the loan proceeds are paid to the seller not to the buyer.

Seller Financing means that the seller is willing convert part of the sale price into a loan (usually in 2nd position behind the bank's loan.

In this situation and using the example in the question, 60% of the loan comes from the bank and 40% comes from the seller's loan. The buyer would responsible for making payments on both loans.

In the event that the business is the collateral for the loan and the buyer defaults, the bank would foreclose and try to sell the business. If the sale price is more than the outstanding balance, the rest would go to pay off the Seller's loan balance.

[EDIT] Let's use an example to see how all the parts work.

We have 3 players: Joe (the seller), John (the buyer) and Bank A.

Joe owns a donut shop It is very popular and very profitable. John wants to own the shop and talks to Joe about selling it.

Joe and John settle on a selling price of $1 million.

John has a problem because he knows that Bank A will only loan up to 60% of the appraised value (let's assume the appraised value is also $1 million). Joe doesn't have enough cash to handle the other 40% needed to complete the transaction.

Joe says to John that he (Joe) will lend him the remaining money so the business can get sold. Joe does this because he would prefer having a stream of income over several years over having to work at the donut shop anymore.

Joe, John and Bank A all agree to this deal.

Here is what happens next:

Bank A send $600,000 to Joe NOT John. This is how these things work. I was in the banking industry for 10 years and it always went this way.

Now John owes $600,000 to Bank A.

In additional John owes Joe $400,000 for the portion that Joe is financing (this is the Seller Financing).

John will be making monthly payments on 2 loans. One to Bank A and one to Joe.

It is not any more complicated than that.

To expand on user70903's answer and hopefully address some of the confusion you seem to be having... conceptually the "other 40%" (lent by the Seller) can be thought of as "paying in instalments", as – even less so than with the 60% lent by the bank – the amount loaned never touches the Buyer's hands.

Thinking of it as two loans:

• The Buyer borrows 60% ($600,000) from the Bank. Whether this money actually touches the Buyer's hands or not is more-or-less irrelevant: it will end up with the Seller as part-payment for the business.

• The Buyer borrows the remaining 40% ($400,000) from the Seller. Conceptually, the Buyer takes this money and immediately gives it to the Seller to complete payment for the business. In practice, no actual money will change hands.

• The Bank has an outstanding $600,000 loan which the Seller will be paying back (+interest) according to whatever schedule was agreed.

• The Buyer has two loans totalling $1,000,000: $600,000 with the Bank; $400,000 with the Seller. The Buyer will pay off these loans (+interest) over whatever schedule was agreed with each.

• The Seller has (conceptually) received $1,000,000 from the Buyer, albeit that $400,000 of that money was leant to the Seller in the first place. In "real" money, they have $600,000 more than they started with. The Seller also has that outstanding loan of $400,000 which the Seller will pay back (+interest) according to agreed terms.

• At the end of both loans' periods, the Buyer will have repaid $600,000 (+interest) to the Bank and $400,000 (+interest) to the Seller. The Seller will now have (assuming they've not spent the original payment) $1,000,000 (+interest). The Buyer will have paid out $1,000,000 (+two lots of interest).

Thinking of it as paying in instalments:

• The Buyer borrows 60% ($600,000) from the Bank, as before.

• The Buyer promises to pay the Seller the remaining 40% ($400,000) by instalments over an agreed period, probably with charges added for the being allowed to do so.

• The Bank has an outstanding $600,000 loan, as before.

• The Buyer has one loan for $600,000 with the Bank; and a promise to pay $400,000 (+charges) in instalments to the Seller. The Buyer will pay off the loan and make instalment payments over whatever schedule was agreed with each.

• The Seller has received $600,000 from the Buyer. They also have a promise to be paid the remaining $400,000 (+charges) to be paid as agreed.

• At the end of the loan's period, and after the last instalment has been paid, the Buyer will have repaid $600,000 (+interest) to the Bank and $400,000 (+charges) to the Seller. The Seller will now have (assuming they've not spent the original payment) $1,000,000 (+charges). The Buyer will have paid out $1,000,000 (+interest, +charges).

Essentially, both viewpoints amount to the same thing: the buyer gets 60% of their money now, and the remaining 40% over an agreed period. In one case that 40% is repayment of a loan (+interest); in the other it is a series of deferred payments (+charges).