Let’s assume you are ready to sell your business and you are reviewing two competing offers, both compelling in their own way.

The first option is for an all-cash payment at closing for $1 million. Option two also is for $1 million, but the buyer asks the seller to accept payment over the course of the next five years at an interest rate of 7%.

All other things being equal, which structure is best for the seller?

As the first option is straightforward, let’s consider the nuances of the second option. Option two is in the form of an owner-carried contract, and it might present an interesting offer for the business owner. Often, owners worry about how they might produce income once their income-producing "baby" is gone. In this case, the buyer offers a solution—making payments over time to allow the seller the cash flow to which he or she is accustomed.

There are several things that the seller should consider before settling on the second option.

First, why is the buyer using the seller for the loan when banks are in the business of making loans? Usually, this is because the buyer is unable to obtain bank-financed lending on the terms proposed. If the buyer could get better terms from the bank, there would be no reason to have the seller carry the contract. This suggests that a bank would charge more. The seller should consider this and plan to charge an interest rate higher than that offered by local banks for a similar transaction with similar collateral.

The seller doesn't want to be in a position of offering financing below bank rates, leading to the perverse economic incentive for the buyer to delay payoff. The seller would further want to ensure proper and abundant collateral from the buyer to ensure payments are made in a timely manner.

One big potential positive of Option 2 is the ability for the seller to treat the sale as an installment sale and thus spread gains over many years, reducing the overall tax burden to the seller. Because of the nature of installment sales, the seller would pay tax on a portion of the gains each year that payments are received.

But consider a couple of important trade-offs. First, an installment sale means that the seller can't rely on current income and capital gains rates. That is, if taxes go up, the seller would likewise be subject to potentially higher taxes in the future. It's an important point. Ask yourself if you think taxes will go up in the future? The seller has the choice: Lock in current tax rates now or claim installment-sale treatment to pay the taxes over time as payments are received under the tax imposed at the time of receipt.

The second important tradeoff is the risk of nonpayment. For most, that's the bigger issue. Assume in the transaction that the seller received excellent collateral, which is not always the case. Good collateral might include the business itself—stock or equipment or inventory being sold as well as things like a mortgage on the buyer’s personal residence.

Assume the buyer misses a payment. How much time goes by before the seller says something? How much time before the seller has to engage an attorney. How much time after engaging an attorney until payment is received or collateral is seized? How much will all this cost the seller? How important is prompt payment to the seller?

The experience of having a buyer fail to make payment is emotionally devastating, as well as expensive and complex for the seller. Ask your attorney for guidance. What experience do they have with buyers not making payments and what effect has that had on the seller? It happens, and it happens sometimes with the same buyer consistently failing to pay the amounts when due.

Although Option 2 offers the potential opportunity to lower taxes and maintain an income stream for the buyer, it isn't without substantial risk. If a seller chooses that option, the buyer should pay interest at or above commercial banking rates. The seller also should make sure to obtain excellent collateral to seize in the event of nonpayment. Finally, the seller should require a personal guarantee from the buyer—if buyer is a corporation—to be able to seek proper recompense from the personal net worth of the buyer’s owner.

Back to the original question: Which deal should you choose? There is not necessarily a correct answer. But, given the uncertainty with Option 2, if it were my decision, I would choose Option 1. As the saying goes, "A bird in the hand ... ."

Beau Ruff is an attorney and director of planning at Cornerstone Wealth Strategies Inc., in Kennewick, Washington.