When Worlds Collide: Seller Financing and SBA Loans

By Cliff Ennico

May 4, 2021 6 min read

"I read your recent column on selling a business and found it very useful when someone approached me a month ago offering to buy my small retail business. My wife and I have been thinking about retiring in Florida for some time now, so we felt that now was the time to make the move.

"Except we hit a snag and don't know what to do about it.

"The buyer told us he was willing to pay the purchase price in full, but then told us later on that he wanted to get a Small Business Administration loan to finance working capital for the business going forward. We told him this was fine, even though it probably would delay the closing of the sale for a while.

"He then told us he would get a more favorable deal with his SBA lender if my wife and I deferred a portion of the purchase price; he offered to pay 10% of the purchase price in monthly installments over three years with interest at 6% per annum. Again, we said OK.

"We just received the closing documents from the SBA lender, and they say we have to wait 10 years before the buyer could begin making his monthly payments of the deferred 10%.

"Needless to say, my wife and I are not happy. We are both in our 70s and are not sure we can wait 13 years to get the full purchase price for our business. The buyer was very apologetic but said the bank wouldn't be flexible and that this was a requirement for them to get a loan guarantee from the government.

"Is this true, and if so, how do we deal with it?"

Section 7(a) loans are frequently used to finance the purchase of existing small businesses, but SBA regulations create a particular challenge in acquisitions where the seller of the business is financing a portion of the purchase price.

In such situations, the buyer delivers a promissory note to the seller agreeing to pay the deferred portion of the purchase price over a period of time (usually three to five years).

In the past, Section 7(a) borrowers had to put 20% to 25% equity down if they wanted to purchase a new business, but with recent changes in SBA acquisition guidelines, the SBA can fund up to 90% of a business acquisition, with a seller note being able to fund 5%. Borrowers must still contribute 5% equity at closing. As a result, the seller holding a promissory note must be put on "full standby" until the SBA loan is fully paid off. As SBA loans typically have a maturity of between five and 10 years, this means the seller does not see a penny of the deferred purchase price for that period of time (except perhaps for payments of interest during that period).

Needless to say, most sellers are not happy about this.

I wouldn't beat up on this buyer too badly; whoever sold him on an SBA loan did not mention this important detail (as promoters frequently don't). Instead, see if you and the buyer can reach a "deal on the side" that will get you paid quicker without violating his loan agreement.

One way to solve the problem is to structure the seller's promissory note as if it were a 10-year obligation but with a "balloon payment" at the end of the third year. This will give the buyer the benefit of a much lower payment during the first three years while giving you some assurance that you won't have to wait until Doomsday to get paid.

Another possible solution is for the buyer to sign the SBA standard form of 10-year note but then hire you and your spouse as consultants for three years for a monthly consulting fee that — by sheer coincidence and happenstance — is the same as the monthly principal and interest payment on a three-year promissory note at 6% per annum (to figure out the monthly payment amount, go to the Bankrate website). At the end of the three-year period, the consulting agreement would expire, and the fees paid under that agreement would be credited, dollar for dollar, against the buyer's liability under the "standby" promissory note, effectively liquidating the latter obligation.

What about taking a lien on the business assets to secure the seller note? A Section 7(a) SBA lender will never allow a seller to have a prior, or even co-equal, lien on the borrower's collateral. Any seller note secured by the business assets must be clearly subordinated to the SBA lender's lien: This means that if there is a default under either note (yours or the SBA lender's), the SBA lender will be able to foreclose on the business assets and make itself whole before you are even allowed to get into court. Of course, you can always insist on an "all cash" deal and forget the seller note. That may create problems for the SBA lender if it believes your business' cash flow can't support a loan and turns down your buyer. Since potential buyers aren't flocking to your door, a bird in the hand is always better than two in the field.

Cliff Ennico ([email protected]) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our webpage at www.creators.com.

Photo credit: Tumisu at Pixabay

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