Economics behind higher purchase price with higher seller's debt?

September 01, 2020

by a searcher from University of Colorado at Boulder - Leeds School of Business in Las Vegas, NV, USA

What is the economics behind offering a higher purchase price with a higher proportion of the seller's debt in the deal structure to bridge the valuation gap? I understand that the seller's debt can be set up as interest-only for the first few years to improve debt service coverage. It will be great to hear how others have handled this and the reasons for doing so. Thanks in advance for sharing your insights!

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Reply by a searcher
in Portland, OR, USA

We recently did this on a deal. We financed the deal through traditional SBA at the originally appraised value (later appraisal came in above our ultimate purchase price) which was lower than the price on our APA. We decided to bridge the gap in a seller note that was outside of our APA so we could get SBA financing across the finish line. Due to some dynamics in the deal, we pushed the difference between APA stated value and mutually agreed upon value between us and seller into a seller promissory note that was structured more like a capped earn out than a debt note. 0% interest over two years with variable monthly payments based on previous month sales performance. So ultimately this got the seller to the number he needed (at the end of 2 yrs) and we agreed too, allowed us to use SBA financing, and allowed for flexibility in cashflow in the business while we pay down the seller note. DM if you'd like more specific details.

Reply by an investor
from Boston College in Boston, MA, USA

It can be the most effective (reasonably priced) way to bridge the gap + getting the seller to yes. You'll likely choose to maximize the amount of senior debt you can access to finance the purchase and equity is expensive + finite. Introducing/expanding a seller note can be done without needing to reduce the senior debt meaningfully as long as you keep the cash debt service on the seller note at a reasonable level. Seller note dollars aren't real equity in the eyes of the senior lender, even if you have an interest only period and at a buyer you do need to recognize that it's capital that needs to get paid our before you see value, but it can be an effective vehicle to hit the seller's valuation

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