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Don’t Settle For Zero Percent Interest Payments

It seems like zero percent interest is only an advantage for the buyer of the business. Unless the seller is highly motivated and isn’t able to make a deal without taking zero percent interest. Consider these factors before agreeing to zero percent interest:

• The IRS views seller financing as an installment sale subject to their requirements. They expect the sales contract to include stated interest that is adequate based on a test rate. You can determine the test rate that applies to you at Applicable federal rates (AFRs) rulings published monthly by the IRS.

• If you sell your business using seller financing and choose an interest rate less than the Applicable Federal Rate, when you file your taxes certain IRS rules will apply. As a result part of the sales price will need to be reduced and considered as interest income.

• Business notes like other secured promissory notes are sold at a discount. This is done to compensate for risk and the time value of money. On business notes, note buyers prefer interest rates at least 3% above the prime rate. For lower interest rates note buyers will apply a greater discount to buy your note.

Just as the price you get for your business is based on many factors, so is the price you get for your business note. Some strong factors could more than offset a weak factor.

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Do Bother To Get A Credit Report On The Buyer

Of course a bank would get a credit report on the buyer. But you don’t think you need one. Or it’s too much trouble. Or you already know everything you need to know about the buyer.

There is no question that sound business practices of seller financing include getting a credit report on the business buyer. And note buyers expect that you use such practices to create your business note.

By providing seller financing you are becoming a creditor of the business buyer. As a prospective creditor, the Fair Credit Reporting Act (FCRA) permits you to obtain a credit report on the payor of your note. For more guidance on this topic review Have You Checked Their Credit?

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If You Sell To A Corporation Or LLC Get A Personal Guarantee

A personal guarantee from the business buyer allows the seller to come after any personal assets of the buyer in a default situation. At the time of a default there may be little business assets to pursue.

Business note buyers typically require a personal guarantee from the business buyer. So not doing so either will make your business note unsellable or could substantially reduce the price you get for your note.

By comparison banks often require the business owner’s personal guarantee for loans to small business owners and professional practices.

The SBA requires a personal guarantee for any owners with at least a 20 percent ownership stake.

Unless the buyer has some financial strength through other personal assets, the personal guarantee has limited value. This is another reason to check the buyer’s personal and business credit history.

A business note buyer may overlook the personal guarantee if the business buyer has excellent credit and made a substantial down payment (50% or more) to buy the business.

If you sell your business to an individual, they still could transfer the business or its assets into a corporation or LLC. So consider adding a provision to the documentation stating that the buyer will remain personally liable for the purchase price of the business, including any purchase money business notes carried by the seller.

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Maximize The Collateral Securing The Note

Compared to other secured promissory notes such as real estate notes, business notes are considered to have more risk because of collateral limitations. This is the business note buyer’s perspective.

A business note is defined not to include the real property of the business. A business note that includes the real estate is known as a hybrid. So even though business note buyers want hard assets as collateral for the note, they prefer real estate to be written as a separate note.

This may seem quirky to people outside the business as well as inside the business. But isn’t that a common view of other businesses as well?

The note business has enough history to formulate this underwriting approach. And individual note buyers have their own experience and preferences, along with the restrictions that funding sources may dictate.

So a true business note has collateral composed of furniture, fixtures & equipment; inventory; accounts receivable; intellectual property; and goodwill. Tthe underwriting concern is that in the event of default there will be little hard assets to foreclose on.

Business sellers should keep these concerns in mind for themselves in both selling the business, and to create a quality business note for the future. While business sellers don’t want a default by their business buyer, they do have an advantage over business note buyers. The business seller should be better positioned to take back the business and run it than a note buyer would be.

Here are a few ideas to help:

• Do all you can to maximize the value of your business at the time of sale.

• Find the most qualified buyer you can to successfully operate your business.

• Obtain additional collateral properly documented to secure the note. Any personal property or real estate that the buyer and seller agree on could be acceptable. This refers to collateral beyond what is included for sale as part of the business.

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File A UCC-1

The paperwork to sell a business starts with the Sales Agreement which describes what is being sold and the terms of sale. If seller financing is provided, a Promissory Note is used as the promise to pay and evidence that money is owed to the seller. The Security Agreement lists the items that serve as security for the Note. Of course there are more details in each document.

The UCC-1, the Uniform Commercial Code financing statement, puts the public on notice that the seller has a lien on the assets that serve as security for the note. But this only happens when the UCC-1 is filed/recorded with the Secretary of State in the state that applies.

To sell your business note it is essential that the UCC-1 is filed. Even if you never sell the note you must file the UCC-1 for your own protection. A UCC-1 must be filed to “perfect” your security interest. Doing so makes a claim on the collateral legally enforceable.

The timing of filing the UCC-1 is important. By filing early you establish priority over subsequent creditors. Usually a first-position lien must be completely satisfied before any subsequent creditors can receive any remaining collateral. You can file later but you risk losing priority to another creditor.

To file a UCC-1, authorization by the debtor is required. This is usually provided by a signed security agreement. Keep in mind that the UCC-1 is valid for five years. You can renew the UCC-1 during the last six months.

For more information about UCC-1’s you could start at the website of the Secretary of State where the debtor is located.

Wherever you are on your journey using seller financing to create a promissory note or to sell your note, NoteSolutions is hear to provide you with solutions.

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Encourage Timely Payments

This sounds obvious. But how will you make it more likely? Start by including a late payment penalty in the note. Consider 5% to 10% of the amount of the payment. Besides giving the business buyer more incentive, this puts them on notice that timely payments are important.

An on time history of payments is a positive factor to get a better price for your note. Succeeding at this task includes good documentation. This will give note buyers the proof they are looking for.

Using a note servicing company will help you collect the payments and provide additional services such as depositing funds wherever you direct, providing monthly statements and year-end financial accounting required for the IRS, online access to your account and managing escrow accounts.

Here is a list of loan servicing companies for you to consider:

• Allied Servicing
• Covey Financial
• Del Toro Loan Servicing, Inc.
• Evergreen Note Servicing
• FCI Lender Services
• Home Key Servicing
• Lake City Servicing
• Madison Servicing
• Moat Note Servicing
• Note Servicing Center, Inc.
• Provident Loan Servicing
• Real Estate Property Services
• SN Servicing

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Require Proper Insurance

You should contact your insurance broker for advice on what insurance terms to require. The basic language of a promissory note will refer to insurance required in general. You need to make specific requirements clear, and they should be part of the escrow instructions for the note closing.

Also require that you are provided with certificates of insurance verifying that what you asked for is in force. Verify that you are listed on the policy as the loss payee, trustee or first contract holder. You should receive certificates of insurance annually.

Be mindful that insurance policies can be cancelled or nonrenewed. Subject to the relevant policy provisions insurance certificate holders will be given advance notice. So this is another reason that it is important that you require certificates of insurance annually.

Whether insurance issues are handled properly is another step that adds or detracts from the value of your business note.

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Review My Business Note Worksheet

My suggestion is that you review my Business Note Worksheet before you sell your business. The main purpose of the worksheet is to obtain a quote to sell your business note. However, there are benefits to looking it over ahead of time.

The thrust is to improve the value of your business note. As I’ve stated earlier though, the same concepts can be helpful to make informed choices as you sell your business. Note buyers do have the experience of analyzing numerous business notes and related due diligence.

Seeing what I am asking for in the worksheet will give you ideas to structure the sale of your business, along with creating a business note. Some of the questions in the worksheet have drop down menus that will show you the details considered.

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Maximize The Value Of Your Business

As part of this entire process, maximizing the value of your business is a top priority. Both while you are operating the business and when you are selling your business note. So this task could have the greatest impact on the price you get for your business note.

The value of a particular business can fall in a wide range of numbers. This is somewhat different than the sale of a home, for example, where comparable sales data is often available. This data is less common for small business sales.

Part of the answer lies in finding the business buyer who will place the greatest value on your business. Yet that buyer may not be the one best qualified to maximize the value of your business in the future.

I am not suggesting that I’m the expert here. You have to make the best choices you can with the support of family, friends and qualified professionals.

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Consider A Partial Sale Of Your Note

I have presented this approach throughout this website in a fair amount of detail. Whether you have read any of that or not, I suggest that you consider a partial sale of a business note as part of your strategy before you sell your business.

A partial sale of a note involves selling some of the payments or a fraction of all or a specified number of payments. And partial sales can be structured in various ways to meet your needs. That is part of my job as a note broker to create a solution that works for you and for the right note buyer.

There are business sellers that provide seller financing but don’t really want to. They could be more likely than other sellers to want to sell their note. But they might feel otherwise if they learned more about seller financing. They might feel otherwise as well, if they don’t like the price they are offered to sell their note.

Other business sellers will start with a positive view of seller financing, and be less inclined to sell their business note. New opportunities and challenges could lead them to offer their note for sale.

Since each note stands on its own, you don’t know in advance how much interest note buyers will have in your note. And the terms that make your business sale work, might not create the most desirable note.

Partial sales usually result in a lesser discount than the sale of an entire note. The combination of the payments on the note that you will receive directly, plus the cash you will receive by selling part of your note, are likely to be the best deal for you. That is in addition to the tax benefits of seller financing.

By planning ahead to a partial sale of your note, you are preparing for options that will provide financial flexibility. These options could expand further if you create one or more real estate notes in addition to any business notes. And real estate notes can be used in conjunction with a 1031 Exchange.

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