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I've Offered Seller Financing And The Buyer Missed A Payment. What Happens Now?



Uh oh! You ve offered seller financing and the buyer you sold your business to missed a payment! What happens now? Well, the way the closing attorney usually, and should prepare the paperwork, states that if a payment is missed whether it is a rent payment or a note payment, the buyer is in default under the note. What does this mean? It means that in the worst case scenario you can take back your business. At the very least you should be entering into serious discussions with the buyer and your team of professionals in order to protect your financial interests and to find out why he or she missed the payment and to determine if it is likely to happen again or if this was a onetime freak occurrence.

In a perfect world every seller gets paid in full and every buyer sees great success in their new venture. In reality this doesn t always happen. The way I see it you should always plan for the worst and hope for the best. But, having said that, you should never sell your business to a person you don t feel will act in the best interest of your business. That s why you have to do your due diligence.

Due diligence isn't just for buyers. As a seller you have to know to the best of your ability that you are selling your business to the right person. A person that is going to have the business' best interest in mind. This is especially true if you are offering any amount of seller financing. However, there s only so much you can find out about a buyer and you can never know what is truly in a person's mind and heart.

A good piece of advice is to follow your gut. If a potential buyer gives you any reason to take pause during negotiations then you should seriously consider walking away from the deal.

Contributor: Business Appraisals, Valuations Advisor
The SBA has always required a 10 to 20% carry back from the seller. I don t consider this seller financing. I realize that SBA lending may be more difficult to get now then when I sold businesses (25 Years). One of my responsibilities as a business broker was to protect my sellers in the sale of their businesses. 90% of my sales were through SBA financing. The other 10% were at the sellers choice after I suggested I was not comfortable with the buyer. A number of these failed and the businesses were destroyed before the seller could take them back.

The SBA has always required a 10 to 20% carry back from the seller. I don t consider this seller financing. I realize that SBA lending may be more difficult to get now then when I sold businesses (25 Years). One of my responsibilities as a business broker was to protect my sellers in the sale of their businesses. 90% of my sales were through SBA financing. The other 10% were at the sellers choice after I suggested I was not comfortable with the buyer. A number of these failed and the businesses were destroyed before the seller could take them back.
I have to differ with Bob in that for many businesses in order to get a sale for a price acceptable to the seller, or to get any sale at all, the seller will need to offer seller financing to one extent or another.

Buyers are looking for this and so is the SBA.

For the last couple of years it has become routine for an SBA loan to include seller financing of at least 10% and preferably as much as 20%, and this seller financing has a "stand still" provision so that the seller only begins to collect payments on that financing after two years have elapsed. The reasoning behind this is that the bank (and the SBA) want the seller to tangibly express confidence in the buyer, to have an incentive for the buyer to be successful, and to be a resource to step back in and operate the business in the event of a default while the bank proceeds to re-sell it and re-capture the unpaid debt owed to the bank and the seller.

Some businesses will not qualify for SBA financing because they are not generating enough profit or their business records (e.g., tax returns) are not in proper order. So, seller financing is often the solution.

Even "cash" buyers want the seller to hold some paper for a year or two--maybe 10% to 20%--as an "insurance policy" against any misrepresentations and as an incentive for the seller to help the buyer be successful.

And, I must reiterate. -- Sellers should always retain the services of an experienced business transaction attorney to prepare the Note and include all the appropriate security and collateral to assure the likelihood of it being repaid -- liens on real property, UCC-1 security filings on business assets, re-assignment of lease as collateral security, personal guarantee(s) of the principal(s), etc.

I have to differ with Bob in that for many businesses in order to get a sale for a price acceptable to the seller, or to get any sale at all, the seller will need to offer seller financing to one extent or another.

Buyers are looking for this and so is the SBA.

For the last couple of years it has become routine for an SBA loan to include seller financing of at least 10% and preferably as much as 20%, and this seller financing has a "stand still" provision so that the seller only begins to collect payments on that financing after two years have elapsed. The reasoning behind this is that the bank (and the SBA) want the seller to tangibly express confidence in the buyer, to have an incentive for the buyer to be successful, and to be a resource to step back in and operate the business in the event of a default while the bank proceeds to re-sell it and re-capture the unpaid debt owed to the bank and the seller.

Some businesses will not qualify for SBA financing because they are not generating enough profit or their business records (e.g., tax returns) are not in proper order. So, seller financing is often the solution.

Even "cash" buyers want the seller to hold some paper for a year or two--maybe 10% to 20%--as an "insurance policy" against any misrepresentations and as an incentive for the seller to help the buyer be successful.

And, I must reiterate. -- Sellers should always retain the services of an experienced business transaction attorney to prepare the Note and include all the appropriate security and collateral to assure the likelihood of it being repaid -- liens on real property, UCC-1 security filings on business assets, re-assignment of lease as collateral security, personal guarantee(s) of the principal(s), etc.
Contributor: Transactional Attorney
While I agree with Bob that SBA financing eliminates the risk to the seller of a buyer default, in many deals SBA financing is not an option. SBA lenders, particularly post-recession, are fairly conservative with their loan portfolios. I had one lender tell me flat out that they were looking for reasons to decline an SBA loan rather than reasons to fund them. They may be an exception, but the SBA process is still a hurdle a substantial number of otherwise qualified buyers won't be able to pass.

I've seen a range of buyers in the market that wouldn't necessarily qualify for an SBA loan but are still relatively good credit risks. A seller who is unwilling to sell to these buyers because they can't qualify for an SBA loan may be missing out on solid opportunities to get maximum value for their business.

Having said that, it's important for the seller to determine their level of risk tolerance and willingness to take the business back if the buyer does default. Even with a properly structured note, rights to take the lease back on default and solid collateral, taking back the assets of a failing business is a difficult task.

One other option to consider is offering seller financing and then selling the note to a third party investor once it's seasoned for a few months. If you're planning to go that route it's important to set the note up to be sold down the line by taking the steps third party investors want to see when they consider a purchase.

While I agree with Bob that SBA financing eliminates the risk to the seller of a buyer default, in many deals SBA financing is not an option. SBA lenders, particularly post-recession, are fairly conservative with their loan portfolios. I had one lender tell me flat out that they were looking for reasons to decline an SBA loan rather than reasons to fund them. They may be an exception, but the SBA process is still a hurdle a substantial number of otherwise qualified buyers won't be able to pass.

I've seen a range of buyers in the market that wouldn't necessarily qualify for an SBA loan but are still relatively good credit risks. A seller who is unwilling to sell to these buyers because they can't qualify for an SBA loan may be missing out on solid opportunities to get maximum value for their business.

Having said that, it's important for the seller to determine their level of risk tolerance and willingness to take the business back if the buyer does default. Even with a properly structured note, rights to take the lease back on default and solid collateral, taking back the assets of a failing business is a difficult task.

One other option to consider is offering seller financing and then selling the note to a third party investor once it's seasoned for a few months. If you're planning to go that route it's important to set the note up to be sold down the line by taking the steps third party investors want to see when they consider a purchase.
Contributor: Business Appraisals, Valuations Advisor
There is no reason for a seller to offer financing. If the business is worth the selling price, funding through a SBA preferred lender should be possible for a qualified buyer. If the buyer can't qualify this problem would never arise. The burden of paying the debt would be with the bank if they provide financing.

There is no reason for a seller to offer financing. If the business is worth the selling price, funding through a SBA preferred lender should be possible for a qualified buyer. If the buyer can't qualify this problem would never arise. The burden of paying the debt would be with the bank if they provide financing.
Christina's point on having the right to take back possession of the premises is important. Otherwise you are just repossessing equipment. There is a document I like to obtain in the selling process that ties the note and security agreement together with rights of possession of the premises in the event of default on either note payment of rent payment.

It is called a "Re-assignment of Lease as Collateral Security". I've been using this for decades.

The borrower is re-assigning the rights of the lease and possession of the premises back to the seller in the event of default on the note or lease. To perfect this we get the landlord to sign the document too, whereby he consents to the re-assignment. This way we don't need to get landlord's approval at time of default.
All buyers shouldn't have issue with this because you're carrying paper on them.

The harder signature to obtain is the landlords. We are successful in obtaining that signature most times.

Christina's point on having the right to take back possession of the premises is important. Otherwise you are just repossessing equipment. There is a document I like to obtain in the selling process that ties the note and security agreement together with rights of possession of the premises in the event of default on either note payment of rent payment.

It is called a "Re-assignment of Lease as Collateral Security". I've been using this for decades.

The borrower is re-assigning the rights of the lease and possession of the premises back to the seller in the event of default on the note or lease. To perfect this we get the landlord to sign the document too, whereby he consents to the re-assignment. This way we don't need to get landlord's approval at time of default.
All buyers shouldn't have issue with this because you're carrying paper on them.

The harder signature to obtain is the landlords. We are successful in obtaining that signature most times.
Christina's and Lee's comments below about the creditor/seller's right to take back the lease raise an important issue. But, to be clear, the creditor/seller should have the RIGHT to take back the lease, but not the OBLIGATION to take back the lease. Again, a business transaction attorney is essential to proper drafting of the note in order to fully protect the seller.

Christina's and Lee's comments below about the creditor/seller's right to take back the lease raise an important issue. But, to be clear, the creditor/seller should have the RIGHT to take back the lease, but not the OBLIGATION to take back the lease. Again, a business transaction attorney is essential to proper drafting of the note in order to fully protect the seller.
Depending on the size and the length of the note, you should consider who is writing it. Many times the escrow writes a simple paragraph regarding the note and there is no language in regarding default. I recommend getting an attorney to draw up more detailed language on what happens in the event of default so that should the note go into default then it will be easier and cheaper to proceed on the ramifications. The ramification can be a simply late fee penalty to taking back the business but like any contract it is a lot easier to agree to these things upfront rather than after it occurred.

** Something very import to consider when accepting a note on the sale of your business is the lease assignment. If the worse case scenario occurs and the buyer defaults on note, are you still on the lease or was it fully assigned to the buyer? You can't get back into a business that you are on the lease of.

Depending on the size and the length of the note, you should consider who is writing it. Many times the escrow writes a simple paragraph regarding the note and there is no language in regarding default. I recommend getting an attorney to draw up more detailed language on what happens in the event of default so that should the note go into default then it will be easier and cheaper to proceed on the ramifications. The ramification can be a simply late fee penalty to taking back the business but like any contract it is a lot easier to agree to these things upfront rather than after it occurred.

** Something very import to consider when accepting a note on the sale of your business is the lease assignment. If the worse case scenario occurs and the buyer defaults on note, are you still on the lease or was it fully assigned to the buyer? You can't get back into a business that you are on the lease of.
As usual, Mark makes excellent points.

The one thing I would add is that the seller should have had the advice and counsel of an attorney when preparing the Seller Note in the first place. Properly planned, drafted, executed, and perfected, the Note can protect the Seller very well; but, drafted by an amateur or non-lawyer and/or improperly executed or perfected, the Note can be as bad as totally worthless.

This is truly a case where an ounce of prevention is worth a ton of cure.

As usual, Mark makes excellent points.

The one thing I would add is that the seller should have had the advice and counsel of an attorney when preparing the Seller Note in the first place. Properly planned, drafted, executed, and perfected, the Note can protect the Seller very well; but, drafted by an amateur or non-lawyer and/or improperly executed or perfected, the Note can be as bad as totally worthless.

This is truly a case where an ounce of prevention is worth a ton of cure.
Contributor: Transactional Attorney
Peter makes an excellent point that the first step should be to find out what is actually happening first. Just because your note/security agreement allow you to accelerate the note or go after the collateral/take back the business doesn't mean that you necessarily want to do that.

If the missed payment is just a temporary bump in the road it's typically to your advantage to try to work with the buyer rather than forcing the issue.

It's important, however, to speak with your legal counsel before speaking with the buyer, as the way you communicate with the buyer can potentially hurt you legally down the line. For example, if you reach out to the buyer and offer to work things out (which seems like a reasonable approach) you may be setting yourself up if the buyer can't or won't work with you and then later says you've waived your right to accelerate or given them additional time to cure the default. Your counsel can explain how to communicate with the buyer without giving up your rights.

Your note/security agreement also likely have very specific provisions as to how you must contact the buyer regarding a default and the time the buyer has to resolve (cure) the default. If you don't follow those provisions you'll leave the buyer an opportunity to fight your claims once you move forward.

If despite your efforts the buyer still can't or won't perform, you may have no other choice but to proceed to take back the collateral that is securing your note. Note that doesn't necessarily mean taking back the whole business. For example, if you have a small balance left on your note and there are assets that can cover that amount, you may be able to put the buyer in a position where they voluntarily sell (or give you to sell) assets sufficient to cover the outstanding balance.

In California, the process is largely governed by both the provisions of your note and security agreement and the Uniform Commercial Code.

If the business has few or no outstanding liabilities other than your note, you may be able to simply agree with the buyer that you will write off the balance of the note in exchange for the buyer handing over the business. While this sounds like an easy solution, it can, however, potentially open you up to liability for any obligations the buyer has incurred while they owned the business under what's known as "successor liability".

If the buyer has incurred debt, faces tax or payroll issues, has claims against the business, etc. a safer way to approach taking the business assets back may be through a foreclosure sale. Depending on the nature of the business and assets you may be able to hold a sale privately or you may have to hold a public sale.

The process to hold a public sale includes notices published in area newspapers and requires advance planning and notice. You'll typically work with an independent company who can place the notice ads for you, handle inquiries generated, hold the sale on the day you schedule it for, and provide the documentation of the sale once it's over.

Most sellers will be bidding at the sale with the balance of the note. For example, if you're owed $100,000 on the note, you have the equivalent of a $100,000 bid at the foreclosure auction. It's possible that you'll be bidding against other public bidders so it's important to carefully consider how much you'll need to bid to secure the assets at the auction.

Finally, if you are the successful bidder it's very important to handle your acquisition of the assets carefully to ensure that you're not connected with the previous ownership and their obligations. You will need to enter into new agreements with employees, customers, suppliers and vendors and you'll also need to make sure your corporate structure, DBA, business licenses, etc. reflect your new ownership of your old business properly.

Peter makes an excellent point that the first step should be to find out what is actually happening first. Just because your note/security agreement allow you to accelerate the note or go after the collateral/take back the business doesn't mean that you necessarily want to do that.

If the missed payment is just a temporary bump in the road it's typically to your advantage to try to work with the buyer rather than forcing the issue.

It's important, however, to speak with your legal counsel before speaking with the buyer, as the way you communicate with the buyer can potentially hurt you legally down the line. For example, if you reach out to the buyer and offer to work things out (which seems like a reasonable approach) you may be setting yourself up if the buyer can't or won't work with you and then later says you've waived your right to accelerate or given them additional time to cure the default. Your counsel can explain how to communicate with the buyer without giving up your rights.

Your note/security agreement also likely have very specific provisions as to how you must contact the buyer regarding a default and the time the buyer has to resolve (cure) the default. If you don't follow those provisions you'll leave the buyer an opportunity to fight your claims once you move forward.

If despite your efforts the buyer still can't or won't perform, you may have no other choice but to proceed to take back the collateral that is securing your note. Note that doesn't necessarily mean taking back the whole business. For example, if you have a small balance left on your note and there are assets that can cover that amount, you may be able to put the buyer in a position where they voluntarily sell (or give you to sell) assets sufficient to cover the outstanding balance.

In California, the process is largely governed by both the provisions of your note and security agreement and the Uniform Commercial Code.

If the business has few or no outstanding liabilities other than your note, you may be able to simply agree with the buyer that you will write off the balance of the note in exchange for the buyer handing over the business. While this sounds like an easy solution, it can, however, potentially open you up to liability for any obligations the buyer has incurred while they owned the business under what's known as "successor liability".

If the buyer has incurred debt, faces tax or payroll issues, has claims against the business, etc. a safer way to approach taking the business assets back may be through a foreclosure sale. Depending on the nature of the business and assets you may be able to hold a sale privately or you may have to hold a public sale.

The process to hold a public sale includes notices published in area newspapers and requires advance planning and notice. You'll typically work with an independent company who can place the notice ads for you, handle inquiries generated, hold the sale on the day you schedule it for, and provide the documentation of the sale once it's over.

Most sellers will be bidding at the sale with the balance of the note. For example, if you're owed $100,000 on the note, you have the equivalent of a $100,000 bid at the foreclosure auction. It's possible that you'll be bidding against other public bidders so it's important to carefully consider how much you'll need to bid to secure the assets at the auction.

Finally, if you are the successful bidder it's very important to handle your acquisition of the assets carefully to ensure that you're not connected with the previous ownership and their obligations. You will need to enter into new agreements with employees, customers, suppliers and vendors and you'll also need to make sure your corporate structure, DBA, business licenses, etc. reflect your new ownership of your old business properly.

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