The Business of notes - Continued

First of all, remember that when selling a business, especially without real estate, and take back a note, the collateral is not near as secure as with real estate.

For example, when a restaurant is sold, an amount is given to all the equipment. Anybody in the business knows there is a big difference when you buy a stainless steel sink, and when you try to sell one. For this reason, the equipment does not offer much security for the note. It will be the ability of the business and the buyer to generate a cash flow that will support the debt payment, AND THE OWNER, that determines a good business note. For this reason, be ready to supply information on the cash flow of the business, and the experience of the payor.

Also, remember that "goodwill" cannot be used as collateral in small businesses, but it is often the major value in the price of the business. Combine this with the ever increasing bankruptcies, and you can tell that business notes are much riskier than are real estate notes. For example, if I purchase a real estate note, where the collateral is a house valued at $100,000, and the payors do not make the payments, I can foreclose with the knowledge that I have $100,000 collateral. But with business notes, used equipment, or good will are not good security, therefore the discount is going to be steeper…much steeper.

Along the same lines, where 5% down, with 30 years to pay, on a owner occupied house, is more than sufficient to a note buyer, this is not the case with a business note. To have a marketable business note, 30% down is a good standard, with 5 years to pay. Think about this, whether you are selling your business note, or you are going to keep it. If the buyer has virtually nothing into the deal, with the only collateral being used equipment, what security is there for the note? Not much is there?

Lastly is the issue of simultaneous closings. Where is it common place to sell your real estate and your owner financed note at the same time, this is not the case with business notes. Because there are often "gentlemen's" agreements with the sale of a business, or oral promises, it is standard to have around 6 months of seasoning. This gives the new owner the opportunity to see that all the equipment is working, and there are no "surprises", and the new owner is satisfied with the sale. Business note buyers will insist the new owner be in the business for a period of time before risking their money to purchase a business note.

So if you are planning on selling your business and taking back a note, do not expect to get 90% of face value that you might get with a real estate note. Here is a good "nutshell" summary of what to expect when selling a business note.

1. Minimum of 30% equity

2. Six months of seasoning

3. Good credit of payor at the time of note purchase (600+)

4. Expect a discount to give the note buyer a 14% to 20% yield (Yes, this is high compared to real estate notes, but the risk is greater, is it not?) Use your calculator to determine the discount.

5. Length of note not to exceed 72 months

6. Note to be fully amortized i.e. no balloons. If there are balloons, be ready for the note buyer to offer to buy "a partial" of the note.

7. Personal guarantee of payor. (Corporation signature will not cut it)

8. Proof the business and buyer are capable of paying the debt service. (Be prepared to show the IRS information and P&L. "Hiding" income is not going to fly with a note buyer.

9. First lien against all assets. UCC 1 filings.

There is other due diligence that the note buyer will perform, but this will give you an idea of what you are up against when trying to sell your business note.

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This article came from the suggestion of one of you. If you would like to have a subject discussed, be sure to drop me a line.

If you are not familiar with how to determine yields, how to sell a "partial" or how to determine the balance of a note, click here.

Hear ye, Hear ye !!!! THE NOTE PROFESSOR NOTEBOOK is back on EBAY at a discount of $30. Just go to EBAY, and type in "note buying". It should take you right to it. If THE NOTE PROFESSOR NOTEBOOK does not appear, it means it has sold out. Go back again the next day.

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