Structure of Sellers Note

August 18, 2019

by a searcher from Harvard University in New York, NY, USA

Hey SFers, I've been in discussion with a company for a bit, going through LOI negotiations, and one of the sticking points is the nature of the sellers note. Specifically, the seller wants a personal note to back the sellers note. This is difficult for me as I already have to put up a PG for the SBA loan, and the seller then has no skin in the game. I asked my lawyer and he said it's very common for sellers notes to be backed by a personal note.

Have you guys found this to be the case? What are some ways to negotiate around this?

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Reply by an intermediary
from Wake Forest University in Winston-Salem, NC, USA

Hi Long - a little perspective from the seller's side of the transaction...as Deniz mentioned, the vast majority of small business transactions have seller finance (typically 10-15%), and we prepare our sellers for that. However, by providing seller financing, they are taking a risk and are leaving skin in the game. The seller finance note not being paid is contingent on the business not performing, but the seller is taking a risk (and shouldn't bear the ultimate responsibility) for the buyer putting it in the ditch by doing things and taking actions outside of the seller's control or past practices (keeping in mind, seller notes are usually also###-###-#### years, way beyond the point where their influence and the company they sold is much more related to the buyer's ownership/management than what they originally purchased). The seller is also, in many cases, choosing to go with one buyer over another, without nearly the same amount of information, track record, and due diligence that the buyer gets to evaluate about the business. So, to alleviate those concerns and the risks that are out of their control, we almost always see (i) a personal guaranty (which may or may not be worth much in second lien position, but also protects against a buyer just throwing in the towel after they have moved assets away); (ii) a second lien position to senior debt (to Colin's point about not being in a first position that might preclude your future borrowing ability); and (iii) if the seller finance note is large enough (say over $100k), a life insurance policy on the buyer payable to the seller, paid by the buyer (don't worry, given the limited term, declining balance, and the generally younger age of the buyer, these are cheap) - again, another risk out of the seller's control..

Reply by a lender
from University of Missouri in St. Louis, MO, USA

Hi Long, following up on other comments. In short, the seller note should be risky to the seller. The premise of seller notes (generally) is that they have some level of risk in the deal. You are ensuring the company performance is what it is based on their financials. The seller note not being paid is contingent on the business performing. So if they business performs as presented this would be a moot point. Additionally, I would request that they not place a lien on the business, or at a minimum have them accommodate in writing that future business debt will be in a senior lien position. Them placing a lien on the business in lieu of a PG could impact your ability to obtain financing down the road on other opportunities. This includes other acquisitions, lines of credit, building loans, etc.

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