Recently, I have gotten several calls from people wanting to sell their business, carry back a note, then sell their note at closing, or shortly after. They are then appalled at discovering it is easier to swim Lake Superior with rocks on their backs than to sell a business note at closing, and when the note is sold, there is a deeper discount than discounts on real estate notes. In this issue I am going to give the nutshell version of business notes. what you can expect, and what not to expect.

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 EXPERIENCE OF 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. The experience of the payor is IMPORTANT!!!.

Also, remember that "good will" cannot be used as collateral in small businesses, but it is often the major value in the price of the business. In other words, "good will" is virtually worthless when if comes to collateral. 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 of the note is going to be steeper, much steeper.

Along the same lines, where 10% 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?

Another point that is becoming more and more an issue with selling a business note is the location of the business. If the business is in a shopping center where the anchor tenant is a K-Mart, grocery chain, or some other industry that is experiencing a downturn, the note buyer will have to factor in what happens if the anchor tenant moves out. For example, if you sold your restaurant where the anchor tenant is a large department store chain, and the restaurant was relying on the traffic to the department store to generate business, it is easily seen the economic health of the department store chain is as important as the financial health of the restaurant.

Lastly is the issue of simultaneous closings. 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, there are no "surprises", and the new owner is satisfied with the sale. Most 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. DO NOT LOOK FOR SIMULTANEOUS CLOSINGS!!

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. Especially in today's economy. 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 (630+)
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 from the start 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, THE NOTE PROFESSOR NOTEBOOK provides an inexpensive way to learn the concepts of the time value of money. br>
If you have questions on notes or yields Contact Me
I will be happy to discuss your specifics.

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Many of you have emailed me wanting to know my opinion on the Federal Reserve Bank speaker that a local real estate investment group sponsored. I was not encouraged by what the speaker conveyed. The speaker gave a good overview of of some of the dynamics of how we got into this situation. However, he conveniently omitted the chaos we are experiencing was triggered by the Federal Reserve, and they are merely repeating and expanding the actions that got us here in the first place.

For example, he correctly demonstrated how investment banks invested in securities which were back by mortgages. He then showed how these investment banks obtained much of their capital by borrowing from commercial banks. What he failed to demonstrate was the artificially low interest rates set by the Federal Reserve, paved the way for commercial banks to lend money to the investment banks at artificially low rates. In other words, if the market interest rate is 9%, and the Federal Reserve has artificially set interest rates at 3%, this will artificial spread always lead to a bubble being formed. There are no exceptions. In the 80's it was oil that "bubbled". In the 90's it was the dot com bubble. Today it is real estate. We did learn something as to the intention of the Federal Reserve. When asked what the Fed would do when inflation crept in, the answer was, "WE Will NOT LET INFLATION HAPPEN. We learned our lesson in the 70's and 80's".

Apparently they did not learn their lesson, because they are setting in motion another round of inflation. The expansion of the money supply relative to production is the definition of inflation. The Federal Reserve completely ignores, and even denies, THEY ARE THE CAUSE OF INFLATION. The Federal Funds rate is now almost 0%. The Federal Reserve is trying to have us believe this will not have any consequences in the future. History and economic laws tell us differently. When interest rates are artificially low, and couple that with the mass expansion of the money supply and government spending, inflation is inevitable.

I am not sure how they can reconcile not letting inflation happen, while at the same time doing their best to keep assets from devaluing back to market value. When bubbles form, one or the other must happen. These are contradictory, are they not? But they are all wise and all knowing, right?

In the meeting, I asked the question "How do you guys decide what the interest rate SHOULD be?" The speaker was giving a politician response, which was a "no answer" answer. I then asked, "You mean you just GUESS?" This startled the speaker. He then gave a song and dance answer about the economy being a car, and the Federal Reserve in all its knowledge and wisdom, knows exactly when to press the gas peddle and when to apply the brakes. Whenever you hear this type of analogy, be aware the speaker is either trying to intentionally deceive you, is ignorant of economics or both. The economy is not analogous to a machine in any way, fashion or form. The economy is a dynamic matrix of individual exchanges of values, governed by a price system based on economic laws of supply, demand and marginal utility. In short, the economy is nothing more than individuals buying and selling to fulfill their wants and needs. When politicians interfere with the price system, it distorts market process, and gives false signals. In the example of real estate, it encouraged lenders to lend and borrowers to borrower, when they otherwise would not have done so if interest rates were not so low. And therefore, the bubble. It is that simple.

The speaker did give us insight into what we can expect, and it is not good. He indicated the solution to this bubble, and all bubbles, was not letting the market function free of intervention, but just the opposite. His answer was MORE REGULATION. In the politicians' and bureaucrats' world, if they regulate the salaries of banking officials, curtail investment banks, and determine what each of us should be able to earn, all will be well in the economic universe. This regulation mentality completely ignores the fact that the printing of money is not the same as production, and government spending takes resources that are used for productive ventures, and transfers it to non productive ventures. Both the printing of money and government spending are a form of consuming without producing. CONSUMPTION CANNOT EXCEED PRODUCTION. This is an economic axiom that is always completely ignored by politicians and bureaucrats.

In summary, I am not encouraged when those who have control of our money supply want the authority to regulate not only banks, but salaries, investments and industries. Does this mean not to invest in real estate? Heavens no!!! I strongly believe knowing how to buy and sell real estate using owner financing is a must in today's market. Just act out of knowledge, not out of fear or ignorance.

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Because I had prior commitments, regretfully I will not be able to speak at this years NoteWorthy Convention. It will be held Nov. 10th thru 12th. I urge all who have not attended to take advantage of the wealth of knowledge you will receive. By going to www.noteworthyconvention .com and registering before September 30th, you can receive a 30% discount off the regular price by entering the promo code "npnews2009". When you get there, tell Clint and the gang I said "Howdy" from Texas.