As a lender who specializes in SBA loan programs to finance mergers and acquisitions, Live Oak Bank has the resources and knowledge to help small business owners prepare for their next business acquisition. When structuring an acquisition deal, a seller note can be an effective way to bridge the gap if the buyer’s preferred purchase price differs from the financeable portion of the sellers’ asking price.
In simplest terms, a seller note is when the seller agrees to take on a series of debt payments from the buyer. When a seller finances even a small portion of the deal, it shows the lender that the seller is confident in the new owner’s abilities and leadership. The terms of the seller note are negotiated between the buyer and seller; however, it’s important to involve a lender in the discussion early-on to ensure payment terms meet debt service and cashflow coverage ratios. The seller note can also be used to protect the buyer from material misrepresentations, or even key risks such as customer retention or customer concentration through carefully written claw back provisions. Robust and carefully structured seller financing can often make the difference in overcoming critical risk factors with the lender. It can be a win-win for all parties involved.
What is a performance-based seller note?
For added security to the buyer, a lender may suggest tying the seller note to business performance, which is also called a performance-based seller note. In this structure, obligations can be reduced if certain performance criteria are not met. This can be appealing to buyers as it reduces their overall risk since the seller still retains some “skin in the game.”
Here’s how a performance-based seller note works in real life:
Let’s say Peggy owns a manufacturing company and is ready to sell the business to retire. The business is well established and successful with strong historic cashflow. However, one of the company’s existing customers generates a large portion of the company’s revenue, creating a significant customer concentration risk.If the business were to lose this customer, for any reason, this would negatively impact the buyer’s ability to repay the loan. In order to reduce this risk for both the buyer and the lender, the deal can be structured with a performance-based seller note. Let’s say Peggy commits to a $2.88 million seller note. The payments on this note are tied to the performance of the business on a go-forward basis. This way, if the company retains this customer long term, Peggy will get all the payments on the seller note in a timely fashion. However, if the company were to lose this customer, the payments to Peggy would stop, leaving enough cash flow to cover just the SBA loan obligation. Once the business replaces this customer (or wins the customer back) Peggy will begin to get payments on the loan again.
When structuring a business acquisition, an experienced lender will understand the value and inherent risks of a seller note. When appropriate seller notes could be an ideal solution to ensure a deal gets done. Lean on the expertise of a lender like Live Oak Bank to guide you through the pros and cons of this alternative form of capital. Learn more about business acquisition loans here.
FAQs
Not only does the use of a seller's note allow buyers to justify a higher purchase price, but a seller's note can also speed up the closing process since negotiating the terms of a seller's note is much simpler than sourcing and negotiating mezzanine debt, another form of alternative capital.
What is the purpose of a seller note? ›
In simplest terms, a seller note is when the seller agrees to take on a series of debt payments from the buyer. When a seller finances even a small portion of the deal, it shows the lender that the seller is confident in the new owner's abilities and leadership.
What is a note when buying a business? ›
A business note is a legal document that represents a promise to pay a specific amount of money at specified intervals over a set period. Often used in the sale of a business, it outlines the terms of payment between the buyer and the seller and can act as a form of financing for the transaction.
What does it mean for a seller to hold a note? ›
Essentially, it is a written agreement to pay back the debt. This contract dictates the loan terms, payment schedule, interest rate, amortization period, and any other important details the two parties agreed upon. The seller then holds the note until the buyer pays it off in full.
What is the importance of seller and buyer? ›
A importance of a Buyer and a seller allows for the free-flow of feedback and ideas. Over time, this will create a more streamlined, effective supply chain that could have a positive impact on both costs and customer service. Explanation: Sellers benefit through the profits or returns from the goods sold.
What is the risk of a seller note? ›
Seller Note Risk
Because seller notes are generally unsecured and may be subordinated to other forms of debt such as a bank loan or business line of credit, the seller's note is inherently riskier and therefore commands a higher interest rate (typically between 6% and 10%).
What does it mean when the seller will carry a note? ›
“Seller/Owner Will Carry” or “Seller/Owner Financing” is when the owner of the property is financing the loan for the buyer to purchase the property. This means the current owner of the home owes no money on the property and becomes the lender for the home's buyer.
Why are notes important in business? ›
Note taking helps us be more efficient with our time, reduce repeat inquiries to prospects and clients, and helps ensure accuracy with everything we do.
What is the purpose of a purchase note? ›
Buyer creates a purchase order
It serves two purposes. One is to ensure that the goods ordered match the ones that are received. Secondly, the PO number is matched to the invoice to make sure the buyer is charged the right amount for the goods.
What does notes mean in business? ›
A note is a debt security obligating repayment of a loan, at a predetermined interest rate, within a defined time frame. Notes are similar to bonds but typically have an earlier maturity date than other debt securities, such as bonds.
Securing Seller Notes
Seller notes can be secured using collaterals like company assets, personal guarantee and may also include arrangements like imposing limitations on running the business and increasing interest rates.
What is a note issued by buyer to seller? ›
A debit note is the document which is used in the event of purchase returns.
Is a seller note equity? ›
A seller note is a debt security that is issued by the buyer of a company to the seller as partial payment for the company. As a debt security, a seller note has a claim on the company's assets before the equity owned by the shareholders, but the seller note is “subordinated” to the bank loans (“Senior Debt”).
What is the most important factor between a buyer and seller? ›
The first and most important of them is trust. Trust, in many ways, forms the core of the relationship between two parties. Trust can be identified as a willingness of one party to rely on their partner confidently. It is is the main factor affecting the strength of any inter-organizational relationships (Morsy, 2017).
What are the roles and responsibilities of seller and buyer? ›
It is the duty to the seller to deliver the goods and of the buyer to accept and pay for them, in accordance with the terms of the contract of sale.
What brings buyers and sellers together? ›
The correct answer is (a) broker. During negotiations between sellers and buyers, a broker's function is to bring buyers and sellers together in a marketplace and ease each party's buying or selling process.
What is the purpose of a note in real estate? ›
A mortgage note is a legal document that sets out all the terms of the mortgage between a borrower and their lending institution. It includes terms such as: The total amount of the home loan. The down payment amount.
What do you write in a note to seller? ›
Tips on writing a letter to the seller
- Make it personal. Bringing a personal element into your letter is crucial for establishing a connection with the seller. ...
- Keep it simple. ...
- State your intention. ...
- Highlight what you love. ...
- Proofread.
Other Considerations Related to Seller Carry-back Notes
Interest income paid on the seller carry-back note is taxable as ordinary income to the seller in the year in which the interest income is paid to the holder of the note (beneficiary or lender).
What happens when you sell a note? ›
After a mortgage note is sold to another lender, the buyer becomes the new holder of the note, and the borrower will make their future payments to the new note holder. The note seller either will receive a lump sum of cash as payment or a series of payments, depending on the terms of the sale.
