Advice When Using Seller Financing
UPDATE to Advice When Using Seller Financing:
Escrowing Seller Proceeds for Future Performance
Please see the original article (you’ll need to scroll down) – previously published during this busy Acquisition Season.
We have an UPDATE!
>>Seller Proceeds of a sale may actually be held in escrow after closing for future conditional disbursement to protect you – the buyer – from massive client exodus or other non-performance by the seller. If the amount held back is not actually earned by the seller, the funds must revert to the bank to pay down the loan. No, you can’t use that money as working capital, darn it, since it was approved as seller proceeds – that’s the rules.
IMPORTANT: Lenders vary in their acceptance and logistics for this option. One major SBA lender will not do it at all, not being comfortable with post-closing loose ends – others likely have the same opinion. In all cases it will depend on lender’s comfort with the transaction and parties involved. It could cause a future legal entanglement, interrupting or even threatening the buyer/borrower’s business. Keep in mind if pursuing this option – Coffman Capital has a variety of lenders to find the right one for you!
The idea is to have 3rd party legal escrow account strictly enforced as to conditions of disbursement to the seller – or paying down the loan. Most would either prefer it be held by another bank, but maybe not. Interestingly, one particular bank actually prefers to have their own bank set up a money market account – after fully disbursing to the seller as required by SBA. They distrust seller’s attorneys. As is standard procedure for any closing, most lenders do not allow you to use the seller’s attorney of record. Many lenders do not have active depository branches where your business is, so that’s a non-issue.
So – if the idea comes up when talking to your broker or seller, just give us a call at 813-891-1811 and find out how this may work for you as an option. See the original article below for details on seller financing which also works to protect you after closing.
Advice When Using Seller Financing
When you buy a business, and use any type – including SBA – of financing for the bulk of the sales proceeds, you may want to use seller financing for some of it, related to the business’ performance after the sale. This is a good idea, often used for Accounting & Tax practices as well as other businesses from time to time. There are rules lenders impose that make sense, so here goes:
- Lenders – and SBA – do not allow you to change the purchase price after closing due to how the business did in year 1 or 2 or whatever. It messes up all the bookkeeping and lending calculations for sure.
- A Seller Note may have a balance reduction tied to performance. Lenders (and apparently SBA) have decided that does not change the price. Cool! They do not allow for the balance to go up with good performance (see #4).
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- If No. 2 above applies, it cannot be for an SBA “Standby Note” that helps lenders reduce your cash injection. Standby Notes are frozen, so you’d have to have a separate note that has performance targets, i.e. you may end up with an SBA loan, a standby note, and a “full service” note with a balance reduction clause.
- Increases in a Seller Note for good performance are a problem. SBA says NO, and conventional lenders can’t calculate an increase in debt or cash outlay (If you gave yourself the option to pay the seller more in cash), it just won’t work for lending, that’s why a maximum seller balance with targets for reduction will work.
- If No. 2 above applies, it cannot be for an SBA “Standby Note” that helps lenders reduce your cash injection. Standby Notes are frozen, so you’d have to have a separate note that has performance targets, i.e. you may end up with an SBA loan, a standby note, and a “full service” note with a balance reduction clause.
If you could start with lower debt and it “earned itself up” in balance, that would be great, but it doesn’t work for lending because it’s impossible to book the right asset value and figure out the cash flow, right?
We have encountered rare lenders that said the buyer could apply for a Credit Line after a performance period to pay the seller more, but it’s not reliable, definitely not for any SBA loans. It is mentioned here in case someone says they heard of it being done. A bank can do all kinds of things after a time for their customers.
Coffman Capital is all about solutions! Because we get these issues all the time it seemed like a good idea to tell people what we’ve learned.
Feel free to call us with questions – or enlighten us with new information – at 813-891-1811 ext 1!
Be Good, Take Care, and Keep Growing!