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Finding a Viable Business Note Borrower
So what makes a borrower viable for a seller-financed business loan transaction of this type and what is the business note
buyer looking for?
1) An Average Credit Score: At least a 625 FICO middle-score or higher (which is a very average credit rating). As most note
buyers would prefer to see a higher borrower credit rating, it is not mandatory to be higher than a 625 FICO middle-score.
Keep in mind though, the higher the credit score, the higher the offer when you sell it. A 625 FICO score is the bare minimum
when it comes to business loans, so the higher the better. Anything lower than 625 will most likely not be funded. Also, be
sure to confirm the credit score yourself (via an attorney or business broker) and not solely rely on the borrower’s word. A little
due diligence can go a long way.
2) The Ability to Produce a Down Payment (not borrowed): A viable note borrower must be able to put down at least 25% to
30% hard, non-borrowed capital, or more, which will keep the loan's LTV ratio down (which will off-set some risk to the
buyer). Any less and the business seller will risk not being able to sell the debt-instrument for a full buy-out option (maybe a
partial purchase). The more equity in the collateral, the more attractive the note is as an investment to a buyer.
These two above items are at the very top of the list of important characteristics when pricing a business loan out for a full
purchase. If the credit score is below a 625 FICO middle-score or the borrower does not have the ability to put down at least
25% (preferably 30%) or more, the business note may not sell at all (as full-purchase).
Include a Personal Guarantee
A personal guarantee is included with a loan when the borrower is a corporate entity (LLC, etc) and not a private individual. If
a business seller sells their small business to a corporate entity and does not ask the borrower to agree to a personal
guarantee, this could negatively affect the loan’s value on the secondary market by thousands, if not tens of thousands of
dollars. It is that important!
In the case of a loan default by a corporate borrower, the borrower can avoid repayment by dissolving the articles of
organization or incorporation, depending on the entity’s business structure. Once the company is dissolved, in the eyes of the
law, no one can legally be held accountable, thus the holder/seller is out their money. There is absolutely no recourse.
Also, in some cases, keep in mind that some business loans do not even have tangible collateral such as: a client-list or
shares in a company, etc. When it comes to repossessing this type of collateral in the case of default, it could become
extremely tricky to accomplish. It is definitely not like repossessing a car or foreclosing on a property.
As the saying goes, it is like comparing apples and oranges. A simple way to avoid this costly mistake when selling to a
corporate borrower, is to require and include a written personal guarantee by the borrower.
Loan Terms/Loan Amortization
When creating a seller carry-back business note with the intention of selling the loan to an note buyer, one must keep several
things in mind when deciding the loan’s terms and structure:
1) Stay away from interest only structures and balloon payments of any kind (unless the seller does not mind a partial offer).
Structuring a business note as an interest only (I/O) structure with a balloon payment is a very risky proposition in today’s
market, because the borrower would need to be approved for a traditional loan in order to satisfy the balloon payment at
maturity. To a note investor, the bulk of the return on investment (ROI) arises from the balloon payment being paid in full and
on time. Very few, if any, traditional lending institutions will fund these types of requests, which leaves the business seller
stuck with a devalued asset.
2) A typical note investor usually likes to be out of an investment within 5-10 years (depending on the note buyer’s risk
tolerance and investment appetite). Creating a business loan with a 15, 20 or 30 year full amortization loan structure will
likely succumb to a much steeper discount when being priced for a full-purchase. In order to maximize value, it is suggested
to structure the loan as a fully amortized asset and keep the maturity date at 10 years or less. 5 to 7 years is a much safer bet
for those sellers who require absolute maximum value. Anything above 10 years will take a bigger hit, due to a long wait for a
return on investment (ROI).
3) Always keep the loan’s interest rate at least 3% to 6% higher than what the primary lending market is charging. This
means that the loan’s interest rate must reflect the risk that the small business seller is taking, by seller-financing the
transaction in the first place. Keep the interest rate at least 9% to 14%, depending on the borrower’s credit score and down
payment amount. If the borrower wants a 5% interest rate, let them go to a bank for the financing. Plus, a higher interest rate
will protect the seller from a deeper discount when the buyer figures their yield into the equation. The higher the interest rate,
the more shelter the business seller has from the note’s discount.
Loan Seasoning
As every buyer is different, most buyers do like to see at least 3 to 12 months of seasoning before placing a bid on a note for
sale. This particular item does vary between buyers. For the most part, many buyers will most likely decline on a loan that has
not been seasoned at all (simultaneous closing, etc.).
The seller may need to collect at least 3 payments before submitting the note for purchase. This way, there is some sort of
visual indication of positive performance pertaining to the loan. We at AX have been involved in instances that allowed this
item to be waived, due to a large down payment submitted by the borrower at origination (50% down or more).
Out of all of the above listed items, loan seasoning is truly a matter of a investor’s preference. It is mandatory with us at AX to
have a business loan seasoned by at least 3-6 payments before we can buy it.
Payment Record Keeping
Payment record keeping is an extremely important item that must be practiced in order to prove that the privately-held loan
will be predictable as an invest. Record cleanliness is a characteristic that most if not all buyers would review during the
pricing and underwriting of that asset.
It simply requires that the seller produces either canceled checks (proving payments collected), bank statements showing
payments deposited/received (hard-copy or digital), or deposit slips (with bank stamp on them (showing proof of payments
received).
This also goes for the down payment as well. If you cannot prove that money exchanged hands, you will have a tough time
maximizing you profits when selling the business loan to an investor. Also, if you receive money orders from the borrower,
simply make photo copies prior to cashing them. There is no need to make copies if you deposit the money orders into your
bank account (as this will be reflected in the bank statements).
Documents and Closing
Executing the above mentioned suggestions will lay a strong foundation for engineering a high-value business loan that will
successfully sell on the secondary market. Also, always use an attorney to draw up the closing documents (i.e.- the actual
note, the asset purchase agreement and most importantly the security agreement).
When it comes to structuring a business note for resale, corners should never be cut. If they are, a seller should expect
friction, delays, disappointment and of course the possibility of getting stuck with the loan. Properly informing yourself (or your
seller) on structuring a business loan for resale will be the difference between selling it or not.
So what makes a borrower viable for a seller-financed business loan transaction of this type and what is the business note
buyer looking for?
1) An Average Credit Score: At least a 625 FICO middle-score or higher (which is a very average credit rating). As most note
buyers would prefer to see a higher borrower credit rating, it is not mandatory to be higher than a 625 FICO middle-score.
Keep in mind though, the higher the credit score, the higher the offer when you sell it. A 625 FICO score is the bare minimum
when it comes to business loans, so the higher the better. Anything lower than 625 will most likely not be funded. Also, be
sure to confirm the credit score yourself (via an attorney or business broker) and not solely rely on the borrower’s word. A little
due diligence can go a long way.
2) The Ability to Produce a Down Payment (not borrowed): A viable note borrower must be able to put down at least 25% to
30% hard, non-borrowed capital, or more, which will keep the loan's LTV ratio down (which will off-set some risk to the
buyer). Any less and the business seller will risk not being able to sell the debt-instrument for a full buy-out option (maybe a
partial purchase). The more equity in the collateral, the more attractive the note is as an investment to a buyer.
These two above items are at the very top of the list of important characteristics when pricing a business loan out for a full
purchase. If the credit score is below a 625 FICO middle-score or the borrower does not have the ability to put down at least
25% (preferably 30%) or more, the business note may not sell at all (as full-purchase).
Include a Personal Guarantee
A personal guarantee is included with a loan when the borrower is a corporate entity (LLC, etc) and not a private individual. If
a business seller sells their small business to a corporate entity and does not ask the borrower to agree to a personal
guarantee, this could negatively affect the loan’s value on the secondary market by thousands, if not tens of thousands of
dollars. It is that important!
In the case of a loan default by a corporate borrower, the borrower can avoid repayment by dissolving the articles of
organization or incorporation, depending on the entity’s business structure. Once the company is dissolved, in the eyes of the
law, no one can legally be held accountable, thus the holder/seller is out their money. There is absolutely no recourse.
Also, in some cases, keep in mind that some business loans do not even have tangible collateral such as: a client-list or
shares in a company, etc. When it comes to repossessing this type of collateral in the case of default, it could become
extremely tricky to accomplish. It is definitely not like repossessing a car or foreclosing on a property.
As the saying goes, it is like comparing apples and oranges. A simple way to avoid this costly mistake when selling to a
corporate borrower, is to require and include a written personal guarantee by the borrower.
Loan Terms/Loan Amortization
When creating a seller carry-back business note with the intention of selling the loan to an note buyer, one must keep several
things in mind when deciding the loan’s terms and structure:
1) Stay away from interest only structures and balloon payments of any kind (unless the seller does not mind a partial offer).
Structuring a business note as an interest only (I/O) structure with a balloon payment is a very risky proposition in today’s
market, because the borrower would need to be approved for a traditional loan in order to satisfy the balloon payment at
maturity. To a note investor, the bulk of the return on investment (ROI) arises from the balloon payment being paid in full and
on time. Very few, if any, traditional lending institutions will fund these types of requests, which leaves the business seller
stuck with a devalued asset.
2) A typical note investor usually likes to be out of an investment within 5-10 years (depending on the note buyer’s risk
tolerance and investment appetite). Creating a business loan with a 15, 20 or 30 year full amortization loan structure will
likely succumb to a much steeper discount when being priced for a full-purchase. In order to maximize value, it is suggested
to structure the loan as a fully amortized asset and keep the maturity date at 10 years or less. 5 to 7 years is a much safer bet
for those sellers who require absolute maximum value. Anything above 10 years will take a bigger hit, due to a long wait for a
return on investment (ROI).
3) Always keep the loan’s interest rate at least 3% to 6% higher than what the primary lending market is charging. This
means that the loan’s interest rate must reflect the risk that the small business seller is taking, by seller-financing the
transaction in the first place. Keep the interest rate at least 9% to 14%, depending on the borrower’s credit score and down
payment amount. If the borrower wants a 5% interest rate, let them go to a bank for the financing. Plus, a higher interest rate
will protect the seller from a deeper discount when the buyer figures their yield into the equation. The higher the interest rate,
the more shelter the business seller has from the note’s discount.
Loan Seasoning
As every buyer is different, most buyers do like to see at least 3 to 12 months of seasoning before placing a bid on a note for
sale. This particular item does vary between buyers. For the most part, many buyers will most likely decline on a loan that has
not been seasoned at all (simultaneous closing, etc.).
The seller may need to collect at least 3 payments before submitting the note for purchase. This way, there is some sort of
visual indication of positive performance pertaining to the loan. We at AX have been involved in instances that allowed this
item to be waived, due to a large down payment submitted by the borrower at origination (50% down or more).
Out of all of the above listed items, loan seasoning is truly a matter of a investor’s preference. It is mandatory with us at AX to
have a business loan seasoned by at least 3-6 payments before we can buy it.
Payment Record Keeping
Payment record keeping is an extremely important item that must be practiced in order to prove that the privately-held loan
will be predictable as an invest. Record cleanliness is a characteristic that most if not all buyers would review during the
pricing and underwriting of that asset.
It simply requires that the seller produces either canceled checks (proving payments collected), bank statements showing
payments deposited/received (hard-copy or digital), or deposit slips (with bank stamp on them (showing proof of payments
received).
This also goes for the down payment as well. If you cannot prove that money exchanged hands, you will have a tough time
maximizing you profits when selling the business loan to an investor. Also, if you receive money orders from the borrower,
simply make photo copies prior to cashing them. There is no need to make copies if you deposit the money orders into your
bank account (as this will be reflected in the bank statements).
Documents and Closing
Executing the above mentioned suggestions will lay a strong foundation for engineering a high-value business loan that will
successfully sell on the secondary market. Also, always use an attorney to draw up the closing documents (i.e.- the actual
note, the asset purchase agreement and most importantly the security agreement).
When it comes to structuring a business note for resale, corners should never be cut. If they are, a seller should expect
friction, delays, disappointment and of course the possibility of getting stuck with the loan. Properly informing yourself (or your
seller) on structuring a business loan for resale will be the difference between selling it or not.
| We are a Direct Note Buyer... so if you are thinking about selling a mortgage note or business note, contact us today and get your free quote - (800) 698-3650 |
