A business note is created when the owner of the business offers financing to assist in the sale to a buyer. That owner can later sell the business note to a business note buyer — similar to selling to a real estate note buyer, except that business notes are secured by a business rather than by real estate. Due to the specialization needed, there are fewer business note buyers than real estate note buyers. The business note can be created instead of or in addition to using traditional bank financing.
It is usually more difficult and time-intensive to get a bank loan for the purchase of a small business than it is to get a loan for a home or building. This can be attributed to a variety of reasons, but is generally related to the amount of collateral available to secure the loan. In other words, these types of loans are riskier to the lender.
When the seller and buyer of a business agree to move forward with the transaction, they quickly find out that pursuing financing using SBA loans is long and difficult. Using owner financing instead will speed up the process significantly.
According to leading experts, while small business purchase loans issued by conventional lenders dropped by 50% from 2007 to early 2014, at least 225,000 business notes were created annually. One industry website estimates that owner financing was used as a portion of the purchase price in roughly 90% of successful small business sales. As banks continue to retreat from the financing of small businesses, using owner financing to create business notes is an excellent alternative to fill that void.
Guidelines for Business Notes
The list below provides parameters that we utilize when deciding whether to purchase a particular business note. Although we like to see all of these items, lacking strength in one area is sometimes acceptable if the other elements are especially strong.
- Minimum 20% cash down payment by the buyer
- At least one payment has been received from the buyer
- Personal guarantee from the buyer and should have a decent credit score with no recent major delinquencies
- Business is profitable, and annual cash flow for the 12 months preceding the sale is sufficient to cover the new annual note debt
- Term on the note should be 6 years or less, with full amortization (no large balloon payments at the end)
- 1st liens only
You can sell a business note regardless of the industry in which you participate. Yes, we do especially like to see businesses that can weather economic downturns and that have relatively small transaction amounts, but have a lot of flexibility in making offers for various types of notes.
As with other types of notes, business note buyers can purchase all or only a certain number of the payments that you are receiving. Often, selling just some of the payments of your business note (called a partial) is a better option for all concerned, as it results in better pricing and more flexibility for you, the note holder.