Seller financing collateral?

February 25, 2024

by a searcher from Georgia State University in Atlanta, GA, USA

Hello,
Does anyone have suggestions on what to use if a seller requires collateral on a long term seller note? I was thinking we could include in the agreement that the business reverts back to them if we fall more than 60/90 days behind their payments. Does anyone else have any other ideas/suggestions?

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Reply by a professional
from University of Miami in New York, NY, USA

Neilay - your best bet is to do everything possible to ensure that the seller note is truly subordinate. First, if you are having paying issues with the seller, it's highly likely you are having payment or covenant issues with your acquisition financings. The "collateral" on an unsecured, subordinated instrument (the only way seller finance really counts as equity for an acquisition loan) is technically non-existent. If payment issues are a concern, you should be more worried about the primary lender. The ability to support both debts is determined during due diligence. You need to be ready to bail if the numbers don't work to (1) pay the main lender; (2) pay the subordinated financing (i.e. - Seller Note); and (3) make you (and your investors) money.

As for collateral, it may have to be an independent asset from that of the business. You could also have an insurance policy that covers them in case of business interruption, sickness, or death.

I'm happy to discuss your options. You have to make sure that what the seller wants, doesn't blow a hole through your acquisition financing, The acquisition lender is shifting the risk of loss on the seller. The business has to: (1) check out financially, and have a DSCR in excess of the minimum required of the lender, to ensure that you can meet debt service for all; and (2) withstand aggressive due diligence on your part as the buyer because you have to accommodate two lenders, and the DSCR risk associated with that.

Let me know if you'd like to speak - I'm sure we can come up with a creative solution: redacted and###-###-#### .

Reply by a professional
from Villanova University in West Chester, PA, USA

Hi ^redacted‌ - lots of great info above and I agree that if there is a senior lender, they will need to sign off on this and the note will be subordinated. However, the structure proposed in your post can have a significant negative consequence if for instance the non-payment occurs when the note is already 90% paid down. Safeguarding against the automatic reversion of the business is crucial, and utilizing tools like a stock power to establish a stock pledge against the shares can be an effective strategy. However, it needs to be limited so that the pledge decreases over time as the loan is paid down so that in the event of a default, the lender would receive a percentage interest in the business relative to the amount still owed and outstanding. I'd be happy to discuss this further. Feel free to send me a DM or schedule a complimentary consultation call through the link in my bio.

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