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.
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.
Copyright
© H&P Capital
Investments LLC All rights reserved
|