Owner proposed a seller's note for all the debt. What should I consider?
June 05, 2021
by a searcher from University of Pennsylvania - The Wharton School in Portland, OR, USA
I am progressing well in discussions with a husband and wife who are selling their decades-old business and entering retirement. Yesterday they floated the idea of taking the entire debt portion of the transaction themselves as a way to generate a stable interest income stream after selling the business. This is a brokered deal and the intermediary is the one who raised the concept on their behalf without specifics, only the sellers' willingness to discuss replacing the debt I would have taken from a lender with their own note. My perception is that the sellers have a very strong financial position with a diversified portfolio independent of this business. They want a low-risk income stream addition to that portfolio and they trust that I can continue the 30+ year history of profitability with the business and easily cover the loan payments.
Up to this point, my financing plan has been to complete an acquisition using a structure of 15% to 20% personal equity injection, a 15% to 20% seller's note, and an SBA loan from one of the experienced ETA lenders that support this community. I had mentally discarded the concept of higher levels of seller financing as the wishful thinking of YouTube charlatans pitching their courses on how to "buy a company with no money down."
With the right terms, this could be attractive. What are the pitfalls of a 20% equity injection + 80% seller's note structure that I should consider? Do you have recommendations on elements of the terms and conditions I should pursue in the negotiation?
from University of Pennsylvania in Portland, OR, USA
A few additional pieces of information to address other questions / concerns about the situation...
- The sellers are just shy of 70 years old and every evidence is they are retiring comfortably with no motives for leaving the business other than simplifying their lives on a timeline of their choice
- The business has physical assets with fair market value (seller's representation - I haven't validated yet, but seems reasonable) greater than the loan value.
- The sellers have connected well with us (my wife and I) because we are a fair bit older than most buyers they've met and we intend to lead our business together, which is how they have always run the company.
Thank you all for the ideas. It's helpful to add your thinking as I evaluate options.
from State University of New York at Stony Brook in Boynton Beach, FL, USA
The fact that the seller and buyer trust and respect each other is a good start. And the idea of the seller replacing a bank for all debt financing, certainly has its advantages. First, bank fees will be saved. Secondly, the time to closing can be shortened. However, it is critically important that both the buyer and seller go through the same due diligence processes that a bank would normally undertake. The bank’s goal is to avoid a deal going badly because of undercapitalization or other uncovered issues. Aside from the bank making sure that the cash flow from the business is sufficient to keep the business afloat, they will also make sure there is enough working capital to anticipate future growth needs.
So, when the buyer and seller get together to plan their “joint” endeavor, they should carefully respect all the important financial ratios to ensure a successful future, with enough contingency funds in place to anticipate a wide range of future variations.
Furthermore, a good M&A transaction attorney should be used to help ensure that all the above, including representations, warranties and obligations are fair and reasonable for both buyer and seller.