| What to do with your seller financed note |
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You are an entrepreneur and you sold your business. Congratulations! Only, you had to take back a promissory note as partial payment, so you did not take out as much cash as you wanted to. Now what? What if that vacation home in Florida you?ve always wanted requires a down-payment, but your down-payment is locked up in a promissory note? It turns out you have more options than you thought. A specialty finance company may wish to purchase that note and provide you with cash to make your vacation-home dream come true. The specialty finance company should be able to evaluate the note, close quickly on the transaction, and leave you with less risk and more money than you had when you sold the business. The fact that your promissory note is not backed by, say, valuable real estate, should not be a deal-breaker for the specialty finance company. After all, if your entrepreneurial business owned its own building, a traditional commercial bank would have provided all the capital needed at the time you sold your business, and you would not have taken a promissory note in the first place. The bank was not there at the time you sold a business, but the specialty finance company can be more flexible than a bank. Preparation to sell a business promissory note should begin before you sell your business, which is why you should think about these issues ahead of time. In fact, the same factors that make your seller-financed note valuable to you also make the note valuable to a potential note purchaser. You can use this list even BEFORE you sell your business to make sure you maximize your own value and increase your options if you ever want to sell the note. Structures of the note that increase value if you want to sell the note in the future: Down payment How much did the business purchaser provide in cash? The bigger the down payment, the higher the cash-out value of the note because a note buyer will perceive less risk in the note. Amortization Does the note pay principal in addition to interest? The more principal paid monthly, the more valuable the note. Conversely, if there is a balloon payment at the end of the note, the higher the risk for a note buyer. Interest Rate Does the interest rate represent a fair return for the risk of lending money? If the interest rate is a commercial rate such as Prime (currently 7.75%) or above this helps preserve value in the note. Timing Does the note pay off in a short amount of time such as 3 years, or does the holder have to wait 10 years for full payment? The shorter the note, the higher the value. Subordination Is the note 2nd in position to a bank loan or other debt on the business? If another lender gets paid before this note, the note is riskier. Collateral Is the business collateral valuable? If the business does not have hard assets such as real estate, vehicles, and equipment that could be liquidated by an auctioneer, the note is more risky. Security Interest Is the promissory note guaranteed by an interest in all business assets, and is that guarantee recorded with the Secretary of
Personal Guarantee Did the business purchaser offer a personal guarantee to fulfill the note obligation? If the purchaser puts his or her own credit on the line, instead of a bankruptcy-remote entity like a corporation or LLC, a note holder has a number of additional options if it comes to enforcing payment. The good news if you are considering selling your promissory note is that time is on your side. The longer you have received payments on the note, the more valuable the note becomes to a potential purchaser. A promissory note with a good payment history shows a willingness and an ability to pay. In addition, the passage of time usually leads to 1. A more experienced business purchaser and 2. A lower debt-to-equity ratio on the note. One final but essential thought for entrepreneurs with seller-financed notes. Business sellers with notes always ask me: How much will you pay? My answer is that it depends greatly on factors 1 through 8 listed above, but usually we can pay more than you expect. Specialty finance companies discount the seller-financed notes to compensate for the risk of non-payment and the cost of borrowing money. If the answers to factors 1 through 8 above look good, we can offer in the 85% to 95% of face value range. I have heard of companies that offer 45% of the note?s face value, which always makes me wonder if they ever get deals done. There are many cases, however, when it makes sense for both a buyer and a seller to agree on a discount in between these ranges, and a 75% of face value deal is not uncommon either. As an entrepreneur, however, you know instinctively that creating value is in your own hands. If you structure a seller-financed note keeping in mind factors 1 though 8, you are sure to get top dollar when it comes time to sell. Michael C. Taylor is the President and Founder of Cedarcrest Capital LLC, a specialty finance company that purchases a wide range of hard-to-value fixed-income assets. He can be reached directly at 212 812 2280, mtaylor@cedarcrestcapital.com, www.cedarcrestcapital.com |
