Due to the current state of the Credit Markets and Bank Financing, Seller financing is more important then ever in facilitating the actual close of escrow in a Business Sale. Everyone is aware of the difficulties in procuring financing on small businesses these days. Everything must be perfect. At one point a few years ago I think I could have gotten my family dog a loan. Today worthy buyers are still getting rejected. The bail out has not reached Main Street.
Therefore Sellers need to structure their notes properly to secure themselves as safely as possible. There are several factors to consider when carrying a Note. First of all the Seller needs to be realistic in terms of what the business can support in form of a monthly payment. No one knows this better then the Owner who has been operating the subject business. If the business has a monthly adjusted net income or owner benefit of $5,000.00, you can not receive a $5,000.00 monthly payment. The Buyer will expect the business profits to make the payment and leave him some money too. Don't set your Buyer up for failure.
Now to make the Sellers note as "tight as possible", the following terms should be incorporated into the note:
Late Fee: Typical notes will begin having the first payment due 30 days from the close of escrow. A typical Late Fee clause is 10 days from due date and a penalty of 6% of the monthly payment. Personally I like 10 days and 10%. In my 28 years of experience in selling businesses, I've found out that if a Buyer is late once and I remind them of the 10% late fee they will do everything possible to not incur it again.
Collateral: Typically the business assets are collateral for the note. In this case there needs to be a written Security Agreement attached to the note. Most escrow companies will supply the Security Agreement. Read it. Not all are created equal. A good one will require the note holder's (Seller's) consent to transfer the note and note holder's consent to substitute or replace any items of collateral (equipment) with like or comparable collateral. A list of equipment is necessary to be attached to the note and security agreement as these items are part of the Sellers overall collateral. All Security Agreements should also define a Breach so that enforcement of the Note and Security Agreement are "cut and dry'.
UCC-1 Financing Statement: This instrument perfects your note by registering it with the California Secretary of State. Make sure it is listed on the UCC-1 that "all fixtures and equipment are collateral, along with all inventories, cash, receivables, deposits and any other tangible asset that the subject business may have.
Reassignment of Lease as Collateral Security: This is one of the more important items and least known of for securing your note. This is a separate document. I used it all the time in the "old days" before all that loose bank financing and all cash deals. It's very important this document be signed by the Buyer, Seller and Landlord.
In the sale of the business you are obtaining an Assignment of Lease to the Buyer from Seller. In that document the Seller is transferring all of his interest in the lease to the Buyer. If a Buyer were to default on the note, the Seller has to go back through the Landlord in getting possession of the business.
In a "Reassignment of Lease as Collateral Security" the Buyer and Landlord acknowledge that in the event a Buyer defaults on either the rent or note payment, the lease shall revert back to the Seller. The Seller gets the Landlord's and Buyer's consent to take back the premises up front before ever giving possession to the Buyer. Seizing your assets from the Buyer on a Default of the Note does not give you back possession of the Premise. This agreement terminates upon payment in full of the Sellers' Note.
The more complete your note is the more successful you will be in collecting all of your payments. These items also give higher value to your note should you decide to sell it on the open market after closing escrow. I would like to share selling notes with you soon.
About The Author: Lee Petsas has been selling businesses with UBI Business Brokers in Southern California since 1981. In 1999 he became the Owner and Broker for UBI. He is still active daily in Listing and Selling businesses. He has been approved multiple times by Courts as an Expert Witness in the area of Business Valuations. UBI has been in Southern California selling businesses since 1965. You can reach Lee direct at 714-363-0440.
Categories: BizBen Blog Contributor, Deal And Escrow Issues, How To Buy A Business, How To Sell A Business
Comments Regarding This Blog Post
While I am aware of escrow agents, business brokers, business sellers, and CPAs preparing seller take-back promissory notes, please take it from a retired attorney that this is one item that the business seller should definitely have handled by the seller's lawyer. No exceptions. A significant part of the deal -- sometimes the bulk of the "profit"-- can be the loan that the buyer owes the seller. Nothing should be left to chance. Two important reasons to use a lawyer: (1) He/she has the expertise to cover every possible "what if" that could develop when it comers time for the seller to collect on the note; and, (2) the lawyer has malpractice insurance--if the lawyer is negligent in properly preparing the note for the particular circumstances of this unique transaction and therefore the seller can't collect from the buyer, the seller may be able to collect from the lawyer's insurance company, instead.