Owner doesn’t want to hold paper. Ideas?

December 13, 2022

by a searcher from Lousiana State University in Houston, TX, USA

Does the SBA require sellers to hold paper? The owner I am working with doesn’t want a seller note. Regardless, I want the owner to have some skin in the game to assure me the business outlook is good. What have folks done in the past to get owners on-board for a seller note in the 10% range? My main concern is being an unattractive buyer if I press this too hard. The broker has told me that 12 buyers have meetings with the owner over the next few weeks. Ideas how to approach the conversation with the owner??

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Reply by an investor
from University of Pennsylvania in Charlotte, NC, USA

Another perspective is that sellers often have good reason to object to seller financing. The one we see most often is the entrepreneur owner has spent 30 or 40 years exposed to business risk and no longer wants that. Hand-in -hand, the seller has no idea whether the buyer can capably manage the company (assuming no prior track record as owner/operator of a similar company.) So not only is there the usual equity risk the seller has endured for a lifetime, but now the additional risk - which is nearly impossible to evaluate - about the buyer's competence. Unless seller intends to continue on the job daily making operational and strategic decisions post-closing for a prolonged period of time (which he/she is definitely not doing for free), seller recognizes he/she can't prevent buyer from sinking the ship. In my experience, sellers don't usually agree that buyer is somehow entitled to seller financing. I know, blasphemy.

Granted there's intuitive appeal to the seller having "skin in the game", but in a given situation it may not matter much. Is the objective risk mitigation? Assuming your due diligence satisfies you that the business risk is acceptable for the purchase price you're offering, what is gained (except obviously a reduced buyer equity investment) by requiring the seller to hold deeply subordinated paper? Seller can't mitigate the macro, competitor, product, customer, employee, etc. risks. As mentioned, nor can he/she save the day if the new owner manages so poorly that seller intervention would be necessary. Seller "sticking around" holding a note doesn't help a poor deal, inadequate due diligence or uncontrollable business risk. If the idea is that seller paper will compel disclosure of a material risk that would otherwise not be disclosed ... there are a lot of reasons and data suggesting otherwise.

As a buyer/investor, think about your exit 5 or 10 years down the road. A buyer makes you a decent offer, except buyer insists you hold $1mm in seller paper. Are you going to say sure, why not, same as cash. Or maybe you'd look for a better deal?

Reply by a searcher
in Galena, IL 61036, USA

Is it a blanket 'no' from the seller/broker or is that a decision that's been made based on your request? Please don't take offense but is there a chance the seller does not feel comfortable with your credentials of running the business, whereas they may be open to a note if they had more confidence in the buyer? Do you feel you've presented a strong case on your ability to grow the business in the future? I would personally be a little concerned about a seller refusing to hold anything post-sale, although a holdback in escrow as Vinil mentioned would check this box. I also understand that the seller has 12 other potential buyers but if you require a note and the seller refuses, stick to your requirements and be prepared to walk away.

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