When selling a business, a seller may decide to extend credit to the buyer by “taking back a note.” Sometimes this is done in combination with bank financing, but not always. In this discussion we will look at what taking back a note really means and what are the considerations in deciding to extend credit this way.
Taking back a note simply means that the seller accepts a promissory note from the buyer for all or some of the purchase price. A seller may decide to take back a note so that he or she can receive periodic payments over time, to generate an income stream for example, and to earn interest on the principal amount loaned to the buyer. Taking back a note may also expand the pool of buyers who can afford to buy the business. Also, the seller may even choose to sell the note after he or she has accepted it from the buyer.
Once the seller has agreed to finance the buyer’s purchase, the loan structure should be very straightforward. The buyer (the “maker” of the note) executes and delivers the note to the seller (the “holder” of the note) as a part of the purchase and sale transaction. For this reason, the purchase and sale agreement must provide for the seller’s financing and there will likely be a need for other incidental documents (e.g. loan agreement, personal guaranty, security agreement). As with any other promissory note, the holder of the note must keep the original note in a safe place because it is a negotiable instrument (like a check) and having the original note makes enforcement of the promise to pay exceedingly easier if necessary at a later time.
Having a promissory note from the buyer is nice and is evidence of the buyer’s promise to pay the seller the agreed amount of the purchase price. But if the buyer fails to make payments as agreed, the seller may find that he or she will not have sufficient protection if the note was not secured by collateral and other means. For this reason the seller will likely want to make sure that the note is secured by some form of collateral. Such collateral can be property of the buyer (e.g. real property) or it can also be the assets of the business itself. If the financing arrangements are done correctly (e.g. taking care to perfect a security interest by filing a UCC-1 financing statement), a seller may be able to regain the business or at least its major assets in the event the buyer defaults on the note. Another way for the seller to protect him or herself is to get personal guaranties from individuals with greater financial strength who agree to become liable in the event the buyer defaults on the promissory note.
As can be seen, taking back a promissory note gives a seller a useful tool to use in selling a business. However, the simplicity of taking back a note can hide the complications that can arise later if the financing is not properly structured.
This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction. This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation. If you need legal advice, consult a qualified attorney. For more information please visit my website at http://www.palacioslawoffice.com.
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