Tips on Ensuring Repayment of Seller Financing

Per my norm, nothing profound, but have a deal going in which I'm on the seller side, several of the proposed LOIs are highly attractive, but all do ask the seller to provide at least some seller financing (via a Seller Note, which really means a Seller Loan, not talking about earnout concepts here). Seller has been highly reluctant, and ultimately, it's not my place to try to push. Nonetheless, a collection of useful tools that - in addition to the most important and obvious one - good credit analysis - can significantly increase the chances of a seller loan being repaid in full.

I'm going to assume for these purposes that buyer's senior debt is an SBA 7(A) loan and no payments can be made on the seller loan for two years from the date of the senior loan.

Key premise: first priority is to set up a structure that disincentives a default and second priority is comprehensive remedies in the event of default.

A pretty thorough toolkit:


*Thorough coordination and alignment with senior lender.

*Subordination agreement between seller and senior lender, with cross-default and cross-acceleration clauses applying to both loans (having a cross-default in the senior loan agreement = default on junior seller financing causes a default on the senior loan, which borrower will badly want to avoid).

*Second lien on all assets sold (properly perfected with UCC-1s)
*Promissory note from buyer/borrower.
*Secondary personal guaranty from buyer/borrower (secondary in the sense of, first recourse is the collateral, then the guaranty, although of course both are second in line behind senior lender) NB here, while practically not likely to make much difference, you want certain provisions regarding the survival of the commitment in the event of a bankruptcy.
*Consider balloon payment structure, with periodic escrow contribution requirements (logic: requires borrower to put certain amounts of payment in escrow over time, which is verifiable, also gives the business time to stabilize financially, usually adds up to a greater ability to repay in full down the line. NB, certainly equal amortization v. balloon is a complex discussion, with some tax implications).

*Consider setting off any missed payments against indemnity cap, if applicable (you don’t see this one too often, but it’s sneaky effective, buyers don’t like the thought of a lowered indemnification cap).

*Seller loan agreement covenants (lots of iterations, can be classified into financial, negative, and affirmative/reporting) – often a tricky negotiation, as buyer doesn’t want to feel restricted in operation of business, but not unheard of, e.g., for a seller loan to have a DSCR requirement, or a restriction on certain distributions, or restriction on additional debt over $X without consent, etc.

*Can consider a PIK toggle feature (pretty risky, usually don’t advise – but would give the borrower the option to make payment-in-kind interest payments rather than cash at borrower's discretion, , in which case the interest expense for that period s added to the principal).

*Pretty unusual since, typically, sellers want to sell - but can provide for the seller financing to be convertible, such that defaults result in some equity going back to the seller - mostly applicable to an equity purchase, although it can be done with an asset purchase, in which case the convertible rights for the seller are in buyer's operating entity).

*Have only seen a couple times in the SMB world, but can try to get provision providing that if the senior loan is ever taken out (e.g. paid down via a new loan at a lower rate), seller loan also needs to be taken out (in part or in full).

*High penalty interest rate (of limited use, since once we’re at this point, collection becomes more challenging).

Always love to hear other folks' insights and thoughts and please be in touch anytime redacted