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Making the Sale with Seller Financing and Business Notes

In the purchase and sale of any business, the amount of cash trading hands is always one of the major factors in the transaction. The buyer of the business wants to pay as little as possible and get as favorable of terms for himself as he can, while the seller is looking to get as much cash as possible so he can move on to other opportunities.

Even after a price has been agreed upon, however, the saga is seldom over. More often than not, the buyer is not going to be able to borrow enough cash from his friendly bank to pay in full for the business. Depending on the situation, the bank will frequently not even loan any amount of money.

So what are the two parties to do? Well, you know that the answer is often to use seller financing. In fact, 75% of small and medium-size business sales include some level of seller financing, amounting to hundreds of billions of dollars in the U.S. market!

Except for potentially paying a higher interest rate, seller financing is generally not a big issue for the buyer. The buyer is just paying an individual instead of a bank each month.

Occasionally, the seller of the business is happy to take back a note and collect payments over a period of time. However, more often than not, the seller would have much preferred cash right from the beginning so that he can move on to other opportunities or retire in style.

Well, you now have another silver bullet in your holster – offering owner financing and then selling the note. Whether you have tried that in the past or not, you may have a few concerns about selling a business note. Let's explore a couple of those:

MYTH: Buyers of business notes charge outrageously high yields to purchase notes.

REALITY: While business note yields will always be higher than those of, say, a mortgage note (due to the difference in collateral), increased competition over the past few years has brought down the yields significantly. Plus, if there is real estate involved, we can often be even more aggressive.

MYTH: Parameters used by business note buyers are very restrictive.

REALITY: Okay, while this one has a bit of truth to it, the requirements are reasonable and not an issue for most notes. Assuming that the note is a 1st lien, then the following requirements come into play:

  • the business has been and continues to be profitable, and has evidence of positive operating cash flow.
  • buyer has good credit, which generally means a FICO score of at least 625.
  • the buyer put down at least 25% of the purchase price in cash (ensures that the buyer is truly committed and able to weather down cycles).
  • the principal owners have made a personal guarantee on the note.
  • the note has been "seasoned" at least two months (to show that the buyer is happy with the purchase).
  • the note should have a face value of at least $20,000.

Also remember that the seller doesn't have to sell the entire note. If, for example, the seller has a $200,000 note but only needs $40,000 now, we can just buy a certain number of payments and/or part of any balloon payment. After we have received those payments, the note is assigned back to the seller to collect all remaining payments and any balloon payment.

We call this a PARTIAL and use it for specific situations to meet the seller's needs or to meet investor requirements. The legal agreement between the parties specifies exactly what is being purchased and the price.

No matter what your role in the transaction, you need to understand this option to sell business notes. Banks are starting to tighten their lending requirements and to raise interest rates, so the volume of business notes is likely to rise in the coming months and years. By being aware or making your clients aware of the availability of the option to sell business notes, you're likely to increase your chances of selling the business and maximizing the price received.

If you are aware of opportunities in this area or just have questions, we are always happy to speak with you and help make you successful. Click here for more information on how to create and sell a business note or mortgage note.

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Article written by Alan Noblitt. Published with permission from Alan Noblitt, Seascape Capital Inc.