Hello everyone. One question I am often getting regarding SBA financing is the use of seller notes and how the SBA addresses them. In fact I just provided this summary in an answer to another post. However, because the question is so common, I thought I would make a generic post about it as well.
There are typically two types of seller notes used in SBA financing. Those that are in repayment and those that are on standby. Notes on standby cannot receive any payments during the term of the loan. Interest can accrue, but payments are not supposed to be made until the SBA loan is paid off. There are a few main circumstances when a standby note is required. First, if the buyer is only putting down 5% equity and the seller is making up the remainder of the required 10% equity. In this case there must be a seller note on full standby for at least 5% of the purchase price. Secondly, if there is not sufficient cash flow to support all of the required debt amortizing then a seller note can be used but would have to be on full standby during the term of the loan because cash flow cannot support its repayment. Third, if the business does not appraise out but the Borrower agrees to continue to pay a higher price, then some of that over-payment can be put into a standby seller note.
For standard seller notes, there is a wide range of potential repayment options. So long as the buyer, seller, and Bank agree to the options, there is quite a bit of flexibility on what can get done. However, most Banks do prefer the amortization on the seller notes match the amortization on the SBA loan (typically 10 years) so that the seller note does not get paid off quicker then the Bank loan. However, I have even seen some Banks be flexible on the amortization depending on the situation. Some common seller note structures I have seen include the following: a) 10-year fully amortizing note; b) interest only note for one to three years then fully amortizing over the remainder of a 10-year loan term; c) no payments for 1 to 3 years and then fully amortizing over a 10 year loan term; d) 5 year balloon loan where the principal comes due at the end of five-years but the payments are amortized out over 10 years; e) 5-year balloon loan where no payments are required or interest only payments are required for the first five-years and then the remaining principal comes due at 5 years; f) a combination of any of the above plus many other options. If there is a balloon on the seller note, the seller has to be aware that the loan is still subordinate to the SBA lender at that point and the seller cannot take any action without the Bank approval. The Bank would have to approve the buyer paying off the seller at that point. However, some Banks are willing to advance the money via a new loan to take out the seller maturing note if things are performing well on the original loan.
I hope this information is helpful. I am more than happy to discuss any particular scenario at any time and help you figure out what would work best for you, the seller, and the lender. We have over 350+ lending partners we work with and over 50+ SBA partners, and we do a substantial amount of business acquisition finance. I can be reached at any time at --@----.com Thank you.