How best to structure a small business seller financed note

Recently, entrepreneur and investor Michael Girdley (who has a wide Twitter following) discussed the lessons he’s learned from carrying a seller financed note on several businesses he sold. Here’s his post on Twitter:

I encourage everyone to read it, whether you’re a broker or a potential seller. The Note should be structured in such a way that repayment protection to the seller is bulletproof while also ensuring that the sale of the business will go through.

In addition to the points he makes, here are a number of additional themes that we believe will dramatically increase the likelihood of repayment:

  • Absolutely, definitely get a personal guarantee from the buyer. A buyer will be significantly less likely to miss payments or push into default if they know their personal assets could be at risk.

  • Get at least 20-25% down in cash at close.

  • File a UCC lien with the state SOS to perfect your security interest in the business and its assets. The lien will be of record and any future loans will be subordinate to your Note. In the event of a workout or a default, this ensures you have first rights to the business assets. Very similar to having a 1st position Deed of Trust on real estate.

  • Always be in 1st lien position. If the buyer is getting a loan from the SBA or a bank and the seller Note will be in second position, your seller Note could be completely wiped out in the the event of non-performance.

  • Don’t charge a usurious rate (check your local state’s usury laws). But don’t charge too low of a rate either. You want to incentivize the buyer to buy your business, but you also want to ensure that you’re earning an appropriate return for the risk of carrying 70%+ of the balance of the sale. Keep in mind that even SBA loans in today’s (June 2023) environment are priced at 11% to 14%, so you have a lot of room to work with.

  • Make sure your repayment terms are realistic. The borrower should be able to afford the monthly payment. Don’t expect to be repaid if the monthly payment is 4x the business’ historical monthly cash flow.

  • Ideally, get the buyer to pledge other assets such as real estate or even a car. Again, the buyer will be more likely to pay on time if they have an emotional attachment to the pledged collateral.

Have you carried a Note in the sale of your small business? What would you recommend?

If you have questions about how best to structure your Note, feel free to contact us.

And don’t forget to review our Note investment criteria at https://www.sellbusinessnote.com/criteria.

Today's high interest rates favor seller financing and the sale of seller Business Notes

It’s been a while since we last posted and we wanted to reach out and remind everyone that we are still very much interested in buying seller financed Business Notes. In fact, we believe that the macroeconomic conditions favor the sale of most seller financed Business Notes.

As you know, interest rates were historically low until last year. While this was great for Note payors, Noteholders were largely unwilling to part with their Notes because they wouldn’t have been able to take their proceeds from the Note sale and earn as high a return elsewhere. As you might recall, CDs were earning less than 0.25% and 2-year treasury bonds were yielding less than 0.75% in January 2022.

When interest rates are higher, noteholders are more likely to sell their Notes. This is because their Notes, originated in 2022 or 2021 (or even before), were cast at a low fixed rate - by selling their Note and reinvesting the proceeds, they can capture higher returns from other assets. What a difference a year makes! CDs are currently earning 4.5% and 2-yr treasuries are right around 4% - keep in mind that investors can earn these returns essentially risk free, while there is no guarantee that the payor will continue to make monthly Note payments. As a result, we think that now is a great time to broker seller financed notes.

SMB seller-financing may thrive during and after Covid

At the onset on Covid in the spring of 2020, banks virtually paused all lending to small businesses throughout the country. Many acquisition transactions that were in process or even nearing a closing were put on hold. In response to the immediate and severe impact of lockdowns imposed by health authorities, many bankers refocused their attention on PPP and EIDL loans. Most banks and the SBA were completely overwhelmed by the dramatic increase in PPP and EIDL loan requests.

We expect SMB seller financing to be robust in 2021. As banks, credit unions, and even alternative lenders have continued to focus on SBA emergency lending, they no longer have the bandwidth (or even perhaps the interest) to offer purchase money SMB loans. Pre-pandemic, it was already difficult for a SMB buyer to qualify for a SBA 7a loan (approval rates through big banks were reported by some to be as low as 25%); the approval rates are even lower now. While some sellers may opt to keep their business and wait for conventional financing to return, many sellers are learning to accept that the best - and only - alternative in this environment is seller financing.

While we believe that seller financing is a valuable tool to facilitate the sale of a small business, we encourage sellers to consult with an attorney, CPA, or business broker to understand the risks involved.