What are the benefits of seller financing?
July 25, 2024
by a searcher from University of Virginia in Chattanooga, TN, USA
Given that seller financing typically has a much shorter duration and more often than not, includes a personal guaranty, what are the benefits if they don't include some note forgiveness terms? It seems like you are having to pay the principal and interest over 3-5 years resulting in higher total costs over the first few years, which is the most important time to keep total debt service costs down since you are still familiarizing yourself with the business and it's operations.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
1) Many lenders like to see a seller note because it means the seller is standing behind the deal and it takes some of the risk off of the Bank. It also means a lower loan-to-cost for the Bank on the transaction.
2) Seller notes can also provide a buffer if the business valuation comes in low. As an example, on SBA 7A loans the loan amount cannot exceed the value contained in the business valuation. If you have equity and a seller note, the loan amount is lower providing more room if the business valuation comes in light.
3) Most of the time we see the seller note at better terms or similar terms to the senior debt. Often the interest rate is lower than that of the senior debt. Although some seller notes might be short-term amortizations, we certainly see them also matching the amortizations of the senior debt as well.
4) With SBA 7A loans you can use seller notes to lessen the amount of money you need to put down if the seller note is on standby for two years or interest only for two years. This can lower the standard required equity from 10% to 5% or even down to 0% in some circumstances (although a bit more rare).
5) If a seller note is on standby for at least two years, often times lenders will not count it in historical debt service. So this may allow you to pay more for the business if the cash flow was not consistent several years back to support that higher level of payment.
6) You can build forgiveness into seller notes so that a portion if not the entire seller note becomes forgivable if certain future performance metrics are not hit.
7) If there is a default on any of the reps and warranties in the asset or stock purchase agreement post closing, rather than having to sue the seller for damages you can offset those damages to the seller note.
8) Seller notes are typically fully subordinate to the senior debt. That means even if you default on the seller note the seller typically cannot take action against you without the permission of the senior lender. Because of that you have some room if you get into trouble before you cannot pay the senior loan.
9) I would say a majority of the time seller notes are not personally guaranteed. Because the seller note also backs up reps and warranties or has forgiveness, it does not make sense for the buyer to personally guaranty it.
I hope this information helps. If you have additional questions on seller notes you can reach me here or directly at redacted
from University of Michigan in Detroit, MI, USA
First, seller notes are often on standby for the first couple of years, increasing short-term cash flow, giving you a little more space to find your feet having acquired the business. Additionally, buyers can negotiate payment holidays, meaning the note goes back on standby if performance dips below a certain threshold. Again, this frees up cash flow at what could be a crucial time for the business. Finally, and as you've already indicated, forgiveness or an earnout (depending on the deal) can also help the buyer service his or her primary debt burden if the outlook looks less than rosy.
A lot more could be written on this subject. Yet suffice to say, I always recommend to clients that a seller note forms part of the financing mix.
Always happy to discuss in more detail. DM me here or reach out directly at redacted