Promissory Notes and Security Agreements

By Tom Taulli

In the small business world, it is fairly rare to see an all-cash buyout. Most buyers simply do not have enough cash to make the transaction. The solution, of course, is to borrow money. However, a bank typically will not take such a risk; instead, it is the seller that becomes the lender.

What percentage of the purchase price is likely to constitute the borrowed amount? This is negotiable, but it is typical to see anywhere from 25% to 35% or so.

Experience

I've seen many of these types of transactions. Unfortunately, a good portion are not structured properly and wind-up in disputes. Thus, it is critically important to seek the advice of a qualified attorney.

To carry out a seller-financed transaction, you will probably see your attorney draw-up two kinds of contracts: promissory note and security agreement.

The promissory note sets for the economics of the loan, such as the interest rate, term, and conditions.

Getting Security

Next, there is the security agreement. This details the assets that back the loan. Basically, this means that if the buyer does not pay off the loan the seller can take back the assets. A seller can protect himself by filing a UCC statement with the pertinent state or local authorities. This is a notice to any potential creditors that there is a security interest in certain property.

A seller also needs to craft the security agreement so as to have quick access to the secured property in the event of a default. If the property is in limbo too long, it can diminish significantly in value.

The seller may want a personal guarantee from the buyer. No doubt, this involves intricate legal details and negotiations. For the buyer, he needs to think very thoroughly about this. Statistics show that many small businesses fail. If so, the buyer could be liable for debt payments for several years ó even though the asset has no value.

MergerPlace is pleased to have the esteemed Mr. Tom Taulli as the managing editor of our MergerPlace M & A Advisor™ E-zine.

Tom Taulli is an expert in the M&A process. He is the author of the critically acclaimed The Complete M&A Handbook (Random House) as well as six other books written for publishers such as Bloomberg and McGraw-Hill. Tom also teaches M&A at the USC School of Business.

Tom has been quoted extensively in the press, including the Wall Street Journal, USA Today, Barron's, and The Los Angeles Times, and has provided commentary on CNBC, CNN, and Bloomberg TV, as well as appeared on a variety of top radio stations across the country.

Tom's books are available for purchase in our bookstore.

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