Is it a red flag if the business owner won’t consider a seller’s note?
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Welcome to the Buyer Advocate newsletter. I'll be sending out my thoughts on SMBs and M&A each week. Hope you enjoy! Join me in Madison next week: I'm hosting an SMB/ETA meetup in the Madison, Wisconsin area on July 15. Click here for details. Now, let's get to the newsletter: A seller’s note is one of the most powerful ways to finance a business acquisition. If you’re buying a business, I highly recommend negotiating for a seller’s note in the deal, for several reasons. For one, obtaining a seller’s note in your deal structure can result in better financing terms for your deal since the note:
Basically, a seller's note can help lower risk (for you and the lender), and also reduces the equity you need to bring to the table to close the deal. But there’s another huge reason besides financial structure that makes a seller’s note an absolute necessity. In fact, I consider it a HUGE RED FLAG 🚩🚩🚩if the seller isn’t at least willing to consider a seller’s note as part of the deal. Why? Because that tells me the seller doesn’t want their return to be dependent on the business’ ongoing performance. Do they not have confidence in the business going forward? Is something wrong with the business? Do they not believe in the buyer’s ability to operate it? All of these are questions that should go through a buyer’s mind when the seller refuses to entertain a seller’s note. If a business owner is selling a business that he expects will continue operating smoothly for years to come, why wouldn’t he accept a seller's note as part of the deal? It doesn’t have to be a massive portion of the deal. 10% to 20% or so of the purchase price as a seller’s note is pretty common. A huge resistance to a seller’s note, even a small one, is usually a red flag for the buyer to open up the hood and see if there are any concerns about the business that the seller isn’t voicing. If you’re selling a business, you should have conviction that the business you’ve built will continue to function for years to come after you sell. So why wouldn’t you negotiate for a higher purchase price, plus interest you’d earn from a note?
Keep in mind that a seller's note can help align the seller’s interests with yours during the post-close consulting period. Different types of seller’s notes There are different types of sellers notes out there, but the one that I’m most in favor of is a contingent forgivable seller’s note. This one is huge for downside protection. What is a contingent seller note? A note that only requires repayment if financial performance is above a historical financial benchmark. These types of notes can be negotiated to say whatever you’d like, but an example could be that if revenue drops by 20% or more in Year 1 after the acquisition, then the note becomes forgivable. If performance falls below said benchmark, no repayment is made. Another type of seller note that I highly recommend is the Seller’s Note on Full Standby. This is a note that doesn’t require repayment until after the SBA loan is fully paid off. Again, this structure limits risk from the lender’s perspective, giving the buyer more favorable terms. Alternatively, a seller’s note on partial standby means the repayment doesn’t kick in for a year or two after close, for example, Typically, these notes still accrue interest during the standby period. No matter what, make sure you negotiate for a portion of the acquisition to be in the form of a seller's note! If the seller flat out refuses to even consider the idea, it might be time to walk away! Thanks for reading! Feel free to reply directly to this email with questions, suggestions, or comments. Matthias Smith |
Pioneer Capital Advisory LLC
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