Question:

I put an LOI on a $1M ecommerce business, and offered 30% down, with a 6% 10-year note. The broker came back and said the terms were way too low, that seller notes should be prime plus 2-3%, like SBA. Is this typically what seller financing goes for? I was under the impression it was much lower, like 6-7%. Also, what additional terms should I negotiate? Lastly, what are the real advantages if any, of getting a seller note versus an SBA loan?

Answer:

The beauty of seller notes is that they can allow you far more flexibility in both rate and term than what you can expect from a traditional lender.

That being said, the broker is correct; interest rates now average around 7-8% and are generally in line with what you can expect from an SBA-backed loan.

In addition, seller notes are usually over a shorter time period. While there are no hard statistics on this, an average of 3- 5 years is common. As you know, the interest rate is far less important than the term specifically as it relates to the impact on the business? cash flow. As such, it would be in your interest to negotiate a longer term, even at the expense of a one or two percent increase in the rate.

Plus, you will want to include the ability to pay off the loan early and make periodic lump sum payments towards the principal without penalty. On this point, as you get into the business and things are going well, you may find yourself in a position with extra cash in the business. It is an ideal time to offer the seller to buy out the note at a discount.

SBA vs. Seller Financing

There are a couple key issues to consider:

Security:

With a seller note, while you will likely have to sign personally, you will not have to pledge personal security and can use the business assets as security.

I usually joke that the SBA only wants your first-born. While they aren’?t that rigid, it?’s usually not far off; they want as much security as possible in most cases.

Timing:

SBA and its lenders have improved the timing in which they get deals done, but it still is not a quick process.

With a seller note, there?’s no delay whatsoever and the note simply becomes part of the closing documents.

Fees: The fees can be quite substantial with SBA backed loans although the lenders will be kind enough to build these fees into the package and finance them over the note term. However, when you need the money to complete the acquisition, the fees are a small price to pay to get into a good business.