Are you thinking of selling your business? If so, this information will help you.

You may want to sell your business for cash but it's difficult to do so. Potential business buyers who have substantial cash typically use the cash for the down payment on a larger business and then as a cash reserve for operating expenses for their new business.

As you probably know, it's also difficult for many buyers to get bank financing for the purchase of the business. Providing financing to your buyer is an excellent way to sell your business quickly and at your asking price. The financing you provide will be in the form of a seller carry-back business note. A business note can be a good, safe investment; however it can also be a very risky investment. The risk comes from the fact that the value of the business assets and goodwill can decrease very quickly if the business is not operated properly.

The following information will be valuable to you if you are considering selling your business and assisting the buyer with financing by taking back a business note. It tells you how to structure the sale of your business and how to structure the business note to increase the safety of the note.

Buyer's credit

Just like any other lender, you have every right to view any information that shows the buyer is able and willing to honor his credit obligations. Obtain financial statements from the buyer and obtain the buyer's authorization for you to get a credit report showing how promptly he or she is paying current debts. If you decide to sell to a person who has less-than-stellar credit, insist on a much larger cash down payment, and bear in mind that it may be difficult, or impossible, to sell your note. If for no other reason than resale, insist on a 3-Bureau copy of the buyers credit and all three credit scores and don't sell your business without it.

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Down payment

The down payment should be as large as possible, but at least 30% of the selling price of the business. A larger down payment means the buyer has more money at risk, has less debt, and has lower payments. These items make the business note safer and more salable.

Make sure the down payment is paid out of the buyer's funds rather than out of funds borrowed from friends, relatives, or lending institutions. If the buyer is borrowing money for the down payment, consider that he will have less of his own money at risk and that he will have to use income from the business to make payments on the additional loan(s).

Regardless of the amount of the down payment, it should be made through an escrow company, title company, or attorney who is handling the business sale transaction so it shows up on closing documents as a legitimate down payment. An investor who is considering buying your note will want to know that the business buyer made a down payment in real cash. It is difficult to prove a down payment was actually made if it is made outside the escrow company, title company, or attorney.

You should avoid "nothing down" buyers at all cost. Buying a business with nothing down is a shrewd way to acquire a business, but a really bad way to sell one. Making down payments over time ($10,000 today, $10,000 in six months, etc.) is just another version of the "nothing down" purchase. Consider carefully: Do you really want to sell your business to a buyer who is unwilling or unable to financially commit himself or herself to the business you are selling? And if they have little or no money in the deal, what is stopping them from driving the business into the ground, selling off the assets, and leave you with nothing but a worthless piece of paper?

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Amortization (term) of note

The length of time it takes to pay off a note is referred to as the amortization period. Most business notes are fully amortized over three to five years. Some very large notes are amortized over as long as eight years. If the business does not generate enough cash flow (after expenses and a reasonable income for the buyer) to payoff the loan over a maximum of eight years, perhaps you are asking more for the business than it is worth.

The amortization period is determined by the amount of the note, the amount of the monthly payment, and the interest rate. The higher the interest rate and/or the smaller the monthly payment, the longer the amortization period will be.

A business buyer may want a longer amortization period so his payments will be smaller. However, for a seller, the shorter the amortization the better, assuming the business generates enough cash flow to support the payments. To shorten the term of the note, you can ask the buyer to increase the down payment and/or increase the size of the monthly payments.

Both you and your buyer benefits by structuring the note so that the payments can easily be made from the business income. Neither of you benefit by having payments that are larger than the business can support. On the other hand, if you make the amortization period unreasonably long compared to the size of the note, you will create questions in the mind of a potential note buyer about whether the cash flow from the business is actually sufficient to pay the investor on time.

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Balloon payments

Balloon payments on business notes are a terrible idea. Avoid a balloon payment. It is seldom possible for the buyer to accumulate enough cash or obtain financing to pay off a balloon, and statistically speaking, over 80% of balloons don't get paid on time. When the balloon comes due you will probably be faced with the necessity of either extending the term of the note or attempting to get the business back. You may not find either alternative attractive years from now when the balloon payment comes due. If you accept a balloon on the note, you should consider it highly unlikely to impossible that you will be able to sell your note.

If the income from the business fluctuates seasonally, the payments could be scheduled to be higher during the high income months and lower during the low income months.

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Interest rate

An interest rate one or two percent higher than the interest rate on real estate mortgages is a reasonable rate for a seller carry back business note, but don't turn down an otherwise acceptable opportunity to sell your business just because the interest rate is lower than you would like. The interest rate is not extremely important on a business note since it pays off over a relatively short period of time. Although a higher interest rate makes the note more valuable, you should consider that accepting a lower interest rate will probably make it easier for you to sell your business.

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Late payment charges

Be sure to include a late payment penalty in the note. This gives the buyer an incentive to make payments on time. Typical late charges range from 5% to 10% of the amount of the payment. Example: If a monthly payment is $1,000 a typical late charge is $50 to $100. The buyer should not object to this provision if he intends to make the payments on time. If he doesn't make payments on time, you'll find that this amount of money is not adequate compensation for your time, trouble and worry.

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Documents

When you sell your business and take back a business note, there are many documents that need to be prepared. The three main documents, Promissory Note, The Security Agreement, and the Uniform Commercial Code Financing Statement (UCC-1). The note is your evidence that the buyer owes you money. The security agreement lists the items that serve as security for the loan, the duties of the buyer, and your rights in the event the buyer defaults on the loan. The UCC-1, when it is filed with the Secretary of State (and sometimes the county recorder), puts the public on notice that you have a loan on the assets that serve as security. All of these documents should be prepared by a professional, such as an attorney or business broker. Selling a business is NOT the place you want to cut corners and save a few bucks by doing it yourself!

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Personal (individual) liability or Personal Guaranty

It's important to hold the buyer personally liable for repayment of the note. In the event of default, if it becomes necessary to take the business back and resell it for less than the buyer owes you, having the buyer personally liable gives you the right to get a deficiency judgment against the buyer. Some buyers will not agree to personal liability. Instead, they insist on buying the business (and executing a note) in the name of a small, closely held, corporation or limited liability company (LLC), which may have no assets other than the business. When you are presented an offer in which the buyer is a liability limiting entity, consider the possibility that in the event the buyer does not make payments, the only recourse you have may be to take back the business, in unknown condition. Also consider that by the time you take the business back, it may be worth very little since the buyer probably will have allowed it to deteriorate substantially, and likely sold all movable assets.

You have to ask yourself an important question: If the buyer is unwilling to personally obligate himself, in writing, that he will make his payments, why would you simply accept his word that he will make them without it? Without a personal guaranty, there is an excellent likelihood that when things get difficult, as they sometimes do, the payments will stop and you will experience a loss.

If you are selling your business to a person, a personal guaranty is automatic. If the payor on the note is any type of company name or corporate entity, insist on a personal guaranty in writing or find another buyer.

In almost all cases, business note investors will not purchase a business note (with a corporate payor) that does not have a personal guaranty, and it is nearly impossible to get the buyer to sign one after the fact. If you don't get a personal guaranty, assume it will be impossible to sell your note.

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Buyer experienced in your industry

It's not always possible to sell your business to someone experienced in your industry, but it certainly is to your advantage to do so if you are carrying back a note. The more experience the buyer has, the more likely he is to run the business successfully. You want the buyer to be successful so he can make payments to you.

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Insurance

It's important for the buyer of your business to maintain adequate liability and hazard insurance. You should have a copy of the policy showing you as Loss Payee and showing that the insurance company has been instructed to notify you if the policy is canceled or modified for any reason.

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