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 local bank to pay in full for the business. Depending on the situation, the bank will frequently not even loan any amount of money. The answer is often to utilize owner financing.
For the seller of the business, he has the option of holding on to the promissory note or selling it to one of the country’s real estate note buyers that buy mortgage notes for their business. Alternatively, you may be dealing with a real estate note broker, though the difference from a process standpoint is insignificant.
You may have a few concerns about selling a business promissory 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 with our quotes.
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 in note selling, the seller doesn’t have to sell the entire note to a note buyer. 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, feel free to call us at any time. We’re always happy to speak with you and help make you successful.