Business Note – an Alternative Financing Option

A Business Note, as an alternative form of financing, is an option for both business owners and financial consultants who are seeking alternatives to traditional bank financing. A seller of a business who accepts the business note as an option will typically have a greater pool of buyers and a greater rate of success in closing the business acquisition.

When acquiring, or selling a business, one alternative is to have the seller originate the financing and carryback a business note. At first glance many business owners will not want to take this approach. They want their cash and their exit. If an owner looking to sell a business will look at the benefits and not just the perceived costs, they may find that offering Private Finance in the form of a Business Note will be their best course of action.

Advantages of Creating and Selling a Business Note

1. The process of selling a business to an individual can be easier, and less time consuming when the seller agrees to carry a business note, than a buyer pursuing traditional financing.

2. By offering Seller Carryback Financing (Private Finance) a business owner can greatly increase the number of potential buyers for their business, and most likely sell the business at a higher price.

3. When a note is created there are the options of keeping it for monthly income, selling the entire note for a large lump sum, or selling part of the note to meet current financial needs and keeping the remainder for future income.

4. Selling either a portion, or the entire note, frees up capital that can be used for new ventures, or paying off old debt.

5. When a note is created and sold, with the proper guidance, a transaction can be structured that allows the business seller the biggest advantage in achieving the seller’s goals.

When originating a Business Note the terms and interest rate are set and agreed upon between the seller and buyer of the business. The seller of the business accepts the promissory note, which is secured by the business including any inventory and equipment that belongs to the business. The business seller then sells the note to an Investor who is willing to hold the note in exchange for compensation. The Investor can’t go back to the business buyer and change the terms of his purchase agreement, so instead the seller of the note must discount the note. The Investor is compensated from the difference of what the note was originated for and the price he actually pays for it.

Is it Worth Selling a Business Note at a Discount?

Most business note sellers only look at the discount rate and quickly calculate in their head that they are giving up too much money to make the selling of the note an attractive proposition. However, further analysis needs to be completed before a final decision is made.

1. What is your motivation for selling the note? What are your goals? Are you trying to reduce your exposure to risk? Want to pay off debt? Want to try a new venture? Want to take that vacation you and your spouse have always dreamed about? How important is it to accomplish these goals? What are the opportunity costs if you don’t have the lump sum of cash to achieve your goals, or invest in something that pays a higher return? Determine what is a priority.

2. What is the Current Fair Market Value of the business? This is what someone is really willing to pay for the business, and not just an “earnings times x” formula. Real aspects of the industry must be considered in the Current Fair Market Price.

3. How much cash do you immediately require?

4. A Note that is seasoned has more value than a “green” note that doesn’t have a payment history. Are you willing to hold the note for a certain amount of time to allow the business buyer time to prove the capability of making the payments?

5. Are you willing to sell only a portion of the Note (this is called a “Partial Sell”)? The discount rate can be an attractive proposition when only a portion of the note is sold.

The Risk for the Note Buyer

1. Buyer Competency – There is the risk that the buyer may not run the business as efficiently as you have, sales drop, and the buyer cannot meet his obligations to you. Incompetency could lead to late payments, missed payments, or bankruptcy.

2. Industry Changes – Changes caused by influences either within the industry, or regulations governing the industry, can make it increasingly difficult for the buyer to meet the contractual financial obligations.

3. Future Competition – Sales and income of the business may be affected by yet unforeseen competition.

4. Loan to Value – When you are holding a business note you have created financing where, very likely, there is a “negative loan to value.” Example: the business note is for $300,000, but there is only $100,000 of tangible assets.

5. Title Insurance – Business Notes don’t have title insurance that will make good a loss arising through defects of titles, or liens.

6. Time Value of Money – Where a dollar received today is more valuable than a dollar received in the future.

7. Opportunity Costs – When the selection of holding the note ties up capital and prevents potential financial gains from other investments.

There are a number of Business Note Investors who will consult with a Client before the Purchase and Sale Agreement for the business acquisition is finalized. This provides the Seller valuable insight into structuring the Business Note so it can be purchased.

Tips for Business Notes

1. Poorly structured business notes may prevent their sale, so seek professional advice before getting stuck with a financial instrument that can’t be sold.

2. Sellers of business notes need to understand the Investor’s risk for a win win transaction.

3. Private Finance, in the form of a Business Note, is an alternative that should be looked at as a business financing option.

To Your Capital Success,
Brad MacLiver
Specialist in Targeted Acquisitions, Business Funding, and Growth Strategies.