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Understanding Seller Notes in M&A


Mergers and acquisitions (M&A) are a vital part of the global economy, enabling businesses to grow, diversify, and expand their reach. In recent years, the use of seller notes in M&A deals has increased significantly. Seller notes, also known as vendor notes or seller financing, are a type of financing that can bridge the gap between the seller’s asking price and the buyer’s upfront payment.

This article will explore the growing importance of seller notes in M&A, highlighting their benefits for both buyers and sellers, and discussing strategies for getting the most out of using this financial instrument.

What is a Seller Note?

A seller note is a loan from the seller of a business to the buyer, allowing the buyer to complete the purchase. It is typically used when the buyer is unable to secure sufficient financing from other sources. Sometimes the the note creates a deferred payment plan, with the seller effectively becoming a creditor to the business.

Seller notes are typically unsecured, meaning they do not require collateral from the buyer. However, they do offer the seller a degree of protection, as the seller can claim assets of the business in case of default. The terms of a seller note, including the interest rate, repayment schedule, and any other stipulations, are negotiated as part of the M&A deal.

Why are Seller Notes Becoming More Popular in M&A?

There are several reasons for the growing popularity of seller notes in M&A deals.

First, the current economic environment has made it more challenging for businesses to secure traditional financing. Second, seller notes offer a degree of flexibility that is often appealing to both buyers and sellers. Third, seller notes can help to bridge the gap between valuation and buyer’s offer, making deals more likely to go through.

Benefits of Seller Notes for Buyers

Seller notes offer several benefits to buyers, including:

  • Speed: Seller Notes do not require a traditional bank loan application, underwriting, documentation and approval process that can be slow, risky and expensive.
  • Flexibility: Seller notes offer a degree of flexibility that is often not available with traditional loans. For example, buyers can negotiate the interest rate, repayment schedule, and other terms of the note to meet their specific needs.
  • Alignment of interests: Seller notes can help to align the interests of the buyer and seller. The seller has a vested interest in the success of the business, as they are still owed a portion of the purchase price. This can motivate the seller to provide support and guidance to the buyer during the transition period.
  • Access to financing: This can be tough for a number of reasons, including:
    1. Industry: Some industries are more risky than others, and lenders may be less willing to lend to businesses in these industries. For example, businesses in the technology or healthcare industries may have a higher risk of failure from a traditional bank underwriting standpoint, which can make it more difficult to obtain financing.
    2. Business size: Small businesses often have a harder time obtaining financing than larger businesses. This is because small businesses are typically more risky, and lenders may have higher minimum loan amounts.
    3. Credit history: Businesses with poor or short credit history may find it difficult to obtain financing. This is because lenders use credit history to assess a business’s risk of defaulting on a loan.
    4. Lack of collateral: Lenders often require businesses to provide collateral to secure a loan. Collateral is an asset that the lender can seize if the business defaults on the loan. Businesses that do not have sufficient collateral may find it difficult to obtain financing.
    5. Economic conditions: During economic downturns, lenders may be more cautious about lending money. This can make it more difficult for businesses to obtain financing, especially if they are new or have a weak financial track record.

Benefits of Seller Notes for Sellers

Seller notes also offer a number of benefits to sellers, including:

  1. Higher asking price: Seller notes can help sellers to achieve a higher asking price for their business. This is because seller notes make the business more attractive to a wider range of buyers, including those who may not be able to afford to pay the full purchase price upfront.
  2. Steady stream of income: Seller notes can provide sellers with a steady stream of income after the sale. This is because the buyer is required to make regular payments on the note, including interest.
  3. Maintain control: Seller notes can allow sellers to maintain a degree of control over the business after the sale. For example, the seller may negotiate a seat on the board of directors or require the buyer to obtain their approval for certain decisions.

Strategies for Getting the Most Out of Seller Notes

There are a few strategies that sellers can use to get the most out of seller notes:

  • Get a fair valuation: It is important to have the business valued by a qualified professional before negotiating a seller note. This will help to ensure that the seller receives a fair price for the business.
  • Structure the note carefully: The terms of the seller note should be carefully negotiated to protect the seller’s interests. This includes negotiating the interest rate, repayment schedule, and any other terms that are important to the seller.
  • Consider using an M&A advisor: An experienced M&A advisor can help sellers to negotiate a seller note on their behalf and ensure that their interests are protected.

Seller Note Terms

Seller note terms can vary drastically depending on the specific transaction, but there are some common terms that are often included. These terms include the principal amount, interest rate, amortization schedule, term, balloon payment, prepayment penalty, and security.

The principal amount is the total amount of money that the buyer owes to the seller. The interest rate is the percentage of the principal amount that the buyer must pay to the seller each year in interest. The amortization schedule is the schedule of payments that the buyer must make to the seller to repay the principal amount and interest over the term of the note. The term is the length of time that the buyer has to repay the seller.

A balloon payment is a large payment that is due at the end of the term of the note. A prepayment penalty is a fee that the buyer must pay to the seller if they repay the note early. Security is collateral that the buyer may be required to provide to the seller to secure the note.

These are just some of the most common seller note terms. It is important to carefully consider all of the terms of a seller note before signing it, as they can have a significant impact on the buyer’s financial obligations.

Examples of the Use of Seller Notes in Real Transactions

Seller notes can be a valuable tool for both buyers and sellers, and they can be used to structure deals that meet the specific needs of both parties. Here are just a few examples of how seller notes have been used in M&A deals.

  • Case Study 1: A family was looking to sell their business but historically it was difficult to secure traditional financing from a bank. The family offered a seller note to the buyer, who was able to use it to finance the purchase. The seller note had a reasonable interest rate and repayment schedule, which made it affordable for the buyer and allowed the seller to achieve a fair price for their business.
  • Case Study 2: A large corporation was acquiring a smaller company. The seller of the smaller company was concerned about maintaining a degree of control over the business after the sale. The Seller negotiated a seller note that included a seat on the board of directors for the Seller. This allowed the seller to remain involved in the business and ensure that it was run in a way that was consistent with their vision until the note was paid off, which was satisfying to the Seller.
  • Case Study 3: A private equity firm was acquiring a portfolio of assets from two partners who wanted to retire. The partners were looking to generate a steady stream of income after the sale. They negotiated a seller note with the private equity firm that had a long-term repayment schedule and a high interest rate. This provided the partners who were selling with a reliable source of income for many years to come.

These case studies demonstrate how Seller Notes can be a valuable strategic tool to facilitate a M&A transaction.  By offering a seller note, sellers can increase the likelihood of selling their business, achieve a higher asking price, and maintain a degree of control over the business after the sale. Buyers can also benefit from seller notes, as they can provide access to financing and flexibility that may not be available with traditional loans.

Enhance Your Outcome with Astria

Thinking about selling your business or maybe diving into a new venture by acquiring another one? Seller notes could be a game-changer in your M&A journey. By reaching out to us, you can get a clearer understanding of how they can play a pivotal role in achieving the outcomes you desire. Our seasoned M&A advisors have assisted countless clients, just like you, in navigating the intricate waters of mergers and acquisitions. They’re here to ensure that the deal you strike is not only advantageous but also tailored to your unique requirements and interests. So, why wait? Contact Astria today!

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