If you have ever bought or sold a business, you know that getting a bank loan to buy a business is more difficult than obtaining a loan for a house or building. Business loans are riskier for financial institutions largely due to the type of collateral securing the loan.
When you sell a business using owner financing and create a business note, you will want to know all of your options. Selling that business note to a reputable business note buyer is a great way to put cash in your pocket now.
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 10% cash down payment (and preferably more) by the buyer
- At least one payment has been received from the buyer
- Personal guarantee from the buyer, and the buyer should have a good 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 a full amortization (no large balloon payments at the end)
- Performing 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 strong profit histories, but we 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.
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Preparing To Sell Your Business
You may have any one of a number of reasons to sell your business. Maybe you have an exciting opportunity in another area. Or, maybe your current business has too few or too many challenges for you to handle on a daily basis. Perhaps you are just burned out or want to retire.
Whatever the reason, selling a business is not simply a matter of finding a friend who likes the business and getting straight cash from him or her. You will want to do a lot of preparation and homework before thinking of selling the business. Offering owner financing will usually increase the number of potential buyers and increase the amount that you can charge for the business. Here are some things to consider:
- What is the real value of the business? Of course, the best determinant of the value is what a reasonable buyer would pay for the business. Before getting to that stage, find out what similar businesses in your area have sold for, and consider having a business broker or other expert appraise the business. This at least gives you a starting point, and you can then make adjustments up or down to reflect the unique qualities of your business.
- What would a potential buyer want to see for the business? In addition to knowing the price that they would have to pay, they will likely want to see recent financial statements and tax returns, understand whether key employees are willing to stay on, have some information about major customers, etc.
- If you want to open a similar business to the one that you are selling, are you willing to sign a non-compete agreement with the new buyer? What do you think would be reasonable, and what would a potential buyer expect?
- Will potential buyers be likely to be able to do all-cash offers (not likely in most industries), and would banks be willing to lend on the business? You may want to talk with a couple of financial institutions to find out what their parameters are likely to be. Unlike with real estate, much of the value of the business may be in goodwill rather than in the value of the physical assets, and the properties are likely to be leased rather than owned. Banks are rightly concerned about how much to loan when so much of the value is in the goodwill. Most transactions involving the sale of a business involve at least some form of owner financing.
- How would you respond if you sold the business using owner financing and the buyer later defaulted? Would you be willing to take the business back, and is it likely to look anything like what it did when you sold it?
- Once you have sold the business with owner financing, are you going to want to keep the note to collect the monthly payments or will you want to sell the note to a reputable business note buyer?
Setting Up A Business Note
Once you have decided to sell your business with owner financing, you may want to find a good business broker to help you find potential buyers. Of course, an experienced business attorney will also be a key partner for you in the business sale. Team members like these can help you to objectively understand your business, what the selling process and closing process will look like, and how you should weigh the opportunities and risks. Of course, your team will also want to help protect you financially and legally.
Once you have found a buyer for your business, it will be important to have your attorney prepare all relevant documents for you. Two of the most important documents will be the promissory note and the security agreement. The note shows the amount being owner financed, the payment amount, the interest rate, what happens in case of default, etc. When the transaction is completed, you will want to keep the original note in a secure location (a safe or safe-deposit box is a good place). The security agreement shows the assets, inventory, etc. that is the collateral for the note. Having well-done documents protects you in case there are issues down the road, and will help to make the note more marketable should you decide to sell it later.
Be sure that the buyer has the skills and experience to run the business. A buyer without true expertise is less likely to keep the business successful and thus make payments on the note. If you have certain concerns, ask your attorney about adding loan covenants and being able to regularly audit the company financials. You may even want to include in the documents that you have the right to occasionally check with major customers to make sure that the business is performing as it was when you left it.
Although a 10% down payment is suggested above, obtaining an even bigger down payment makes the note safer and more marketable for you, as it lessens the chances of a later default. If the buyer is capable of putting in a down payment of 20% or even 40%, that would be helpful. Make sure that the down payment is all cash and not consisting of other assets or like-kind items. A business note buyer won’t give full credit on a down payment that is not all cash.
Be sure to check the payer’s credit, and don’t take their word for it. Run a credit report to get the true number. A business note buyer will want a credit score of at least 625 but a much higher score will help you to get a better price for your note.
Related to the buyer’s credit is to make sure that the buyer personally guarantees the note. This gives you more assets to pursue if there is ever a default or other issues. A corporate or LLC guarantee could leave you with very little if the business goes under.
Because you are offering owner financing, the interest rate charged should be several points higher than existing mortgage rates. For instance, even if current mortgage rates are 5-6%, the rate on your note should be in the 9-12% range. This higher rate reflects the amount of risk that you are taking on.
Be sure that you document all payments and keep copies of checks or bank statements. Doing this will help in case of any disagreement about the note balance, and will be essential to any buyer of business notes.
Selling A Business Note
If you decide that you want to get some cash out of your business note, you usually have the option of selling the full note (all of the payments) or just some of the payments (see next section). Be sure to find a reputable business note buyer or broker that is experienced and that has an A+ rating from the Better Business Bureau. Of course, Seascape Capital is at the top of all of these criteria.
Here is an overview of the steps in selling a business note:
- Contact the business note buyer, where they will ask for information about the business and the financials, as well as ask for a copy of the note and the security agreement.
- Once the note buyer has all of the needed information, they will make an offer to you to buy all or part of the note. You have the option of accepting one of the offers or deciding to keep the note.
- Assuming that you want to go forward, the business note buyer will ask you for additional information like the payer’s contact information, proof of payments, copies of tax statements, etc.
- When the note investor has everything that they need, they will send assignment documents to the note holder for signature. The note holder signs these and returns them to the note investor.
- The note buyer will wire the funds to the note holder, and send a letter to the payer to start making payments to the new note owner.
- If you have sold the full note, your part is basically done, and you can spend the funds however you would like.
Selling Part Of A Business Note
You may like the future income that your business note provides but want money now to start a new venture, pay off debts, or other needs. When selling your business note, a business note buyer can usually make offers related to buying the full note or only buying some of the payments. As noted above, the latter option is called a partial purchase.
As an example, let’s say that you have a $250,000 note being paid over five years at a 7% interest rate. The monthly payments would be $4950.30. If you only need $100,000 at this time and want to keep part of the note, we might (for example) offer to buy the next 23 monthly payments. After the 23 months are over (or even before that date), you could choose to sell additional payments, if you so desire. There may also be tax benefits to you by deferring some of the gains. Call Alan at Seascape if you would like more information about partials, and whether they would be a good fit for you.