M&A financing involves creative deal structuring and different sources of capital. With different arrangements of financing available, it becomes important for the acquirer to come up with a capital structure that offers the lowest cost of capital. One such financing alternative is seller financing or seller notes.
What is a Seller Note?
Seller note is a type of debt financing usually used while acquiring smaller businesses. Seller Note is a provision where the seller of the business pays some portion of the purchase price in the form of a promissory note. Buyer presents the seller with a written note including details like the interest rate charged, the debt amount, principal repayment schedule and other terms of arrangement like converting debt to equity in case the buyer defaults while honoring the commitment.
Seller Note-A Win-Win Situation
Seller note if utilized well can be a win-win situation for both buyers and sellers. Seller note gives confidence to the buyers in term of seller’s belief in the future of the business. It also offers buyers the flexibility with the loan structure and interest rates.
Not only to the buyers, seller notes also offer a form of guarantee to the banks involved in financing the transaction. They make loans safer for banks considering such lending adds up to the low priority loans on their books. In turn, banks may offer lower interest rates.
On the other hand, seller notes can help sellers get better valuation for the business considering the seller confidence in the firm’s vision and capabilities. It also expedites the process of acquisition. Sellers additionally benefit from tax advantage and interest income.
Securing Seller Notes
Seller notes are riskier than bank loans or business line of credit and hence bear higher interest rates comparatively. However, sellers can secure the debt in times when the business is not able to generate enough cash to repay the debt or in times of high uncertainty. Seller notes can be secured using collaterals like company assets, personal guarantee and may also include arrangements like imposing limitations on running the business and increasing interest rates.
Seller Notes in times of COVID-19
COVID-19 has had a great impact on the smaller businesses in terms of revenue and has thus impacted the purchase price of the business. In such low business environment, banks are also more cautious and are lending with stricter arrangements in place. As a result, sellers are losing out on the valuation multiples they might have commanded in the pre-COVID times. Also, from a business point of view it has been difficult for the owners to sustain in such an environment. Jeff Cunningham from Parker Poe explained more about the impact in his article here: Link
In such difficult and uncertain times, seller notes offer business owners opportunities to hold on to their businesses and at the same time try and get their businesses up and running with the help of investors. This will also boost the M&A activity that is trying to pick up post a period of low activity. Additionally, it also reduces banks’ risks and they are more comfortable participating in such transactions.
Seller notes thus offers sellers and buyers opportunity to be creative while structuring the deals and to be mutually beneficial in terms of transaction.
Sources: ParkerPoe, Forex Education, Grimes, McGovern & Associates, JDSUPRA
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