SECURING A SELLER NOTE
The financial markets are facing some of the most challenging times never seen before in generations, making buying a business a tougher proposition than just 18 months ago. During these times, lenders go to the extreme, as though their parent had just scolded them, and they hunt for any possible reason to decline a business purchase loan.
With Money tougher to find, there is a drift toward sellers taking the banker’s position in a deal. Prior to 2007 seller financing was rare because money was easy to get. But not today! Seller financing is now a common place if the owner wants to sell the business and get their asking price. There certainly are risks, but there are opportunities as well.
What happens if the buyer defaults on the loan? Is the seller reasonably protected? How does one protect against such a default event?
We recently had a buyer default on the lease payments. The buyer paid $325,000 for the business and did an SBA loan for 80%. We advised the Seller to do a sublease with a security agreement. When the buyer defaulted on the rent, the Seller gave him notice, negotiated a settlement with the SBA and got the business back at a fraction of the price he received for it a couple years earlier. Sure, not exactly what he wanted, but he’s now in control of the situation. Most brokers would have done an assignment and the Seller would have been paying the rent with no rights to the business.
Here is how to secure the Seller note: First, get an attorney to help structure the security of the transaction – but not all attorneys know how to do this, so make sure they do. That being said, there are three areas where security is needed: (1) the lease, (2) the equipment, and (3) the real estate assets of the buyer, if any. It’s the agent’s job to advise the seller on how to best secure the note and the attorney's job to draft the security arrangements.
A seller should never accept an offer without having some picture of the buyer's history; financial, credit and experience.
Should the seller review the buyer's history and decide to finance part of the deal, then there are several technical devises used to help secure the loan. A good attorney can structure the security arrangement. And don't be cheap because it could cost you dearly if the buyer defaults and you’re not protected.
SECURED BY THE BUYER’S PERSONAL ASSETS
If the buyer is a corporation, the seller should request the buyer to personally guaranty the loan and the lease. The personal guaranty basically allows the seller to go after all the buyer’s assets in the event of a default, including the buyer’s real estate if there is equity left. But it doesn’t prevent the buyer from mortgaging the real estate, possibly leaving nothing for the Seller to garner. By placing a lien on the real estate, the seller is guaranteed a position in the real estate.
SECURING THE BUSINESS ASSETS
Generally there are three assets to secure in a business: (1) furniture fixtures and equipment (FF&E), (2) the liquor license and, (3) the lease.
(1) THE EQUIPMENT - For the equipment, the seller should have escrow place a UCC financing statement on the business and assets. This of course doesn’t prevent the equipment from walking out. Of course, the buyer would be “stealing” should he/she walkout with the equipment, which is a crime.
(2) THE LIQUOR LICENSE - For the liquor license (California and Arizona Only), the only license with meaningful value is the hard liquor license in California it is the type 47 and 48 and in Arizona it is the number 6 and 7. Values of the licenses vary by county. For example, in Napa, Placer and El Dorado Counties, liquor licenses have been known to trade for well over $200,000.
Securing the liquor license is tricky and presents certain risks to the seller. California doesn't allow a liquor license to be used as security per se. However, unless the buyer makes issue of the structure below, a transfer can be obtained upon default. Whether or not the transfer will be challenged by the liquor license authorities is another issue. Arizona I believe allows liens on liquor licenses.
The risk is clear. If the seller remains on the liquor license, they could have associated liability in the event an accident occurs or someone gets hurt. The seller should seek legal counseling here.
But there is another way to secure those expensive licenses. Each license has a "pink slip." Before escrow closes, have the Buyer sign and notarize the "pink slip." Then have a third party hold the license. In the event the buyer defaults on the lease or the loan, then the third party is instructed to release the "pink slip" to the Seller. The Seller then starts the transfer process. Please consult an attorney to draft legal agreements to implement this unique and SellingRestaurants designed strategy. To be frank, this is not legal in California, but to also be frank, the buyer would have to know it isn't legal. So in my book it never hurts to try.
(3) THE LEASE – Here is where we earn our commission! Sublease versus Assignment: In a sub-lease, the Seller retains the same bundle of rights as though they were the original lessee. In fact, the seller becomes the sub-landlord in essence, with the key right being the right of re-entry.
Under an assignment, the seller loses all rights except the right to pay the rent in the event the buyer defaults. So the agent must suggest a sublease in the situation where the Buyer is financially weak, bad credit and/or lacks experience. The sublease should be coupled with a personal guarantee if it is a corporate entity or trust deed on the buyer’s real estate and UCC-1 financing statement on the restaurant’s assets.
Of course, contact us at 800-576-3615 to help you with your transaction. We know what we’re doing!
Mel Jones is one of the premier restaurant brokers in the nation having published hundreds of articles on buying and selling a restaurant and bar business, selling thousands of restaurants in CA., WA and AZ and building one of the most copied business models in the brokerage industry. Mel started SellingRestaurants in 2004 with the one simple concept, give the buyers the information they need to make intelligent buying decisions without being pestered by a broker or hiding information, prepare the business for market by researching key details that make or break deals and educate the buyer on the buying process to create an intelligent buyer. Prior to SellingRestaurants, Mel was a Chief Financial Officer for Universal Music Group, the largest music company in the world. There he participated in more than $11.5 billion of merger and acquisition transactions. He also work for top companies such as Nestle Foods, USA. He hold a Bachelors in Business Administration Finance as well as attended Law School at Gonzaga University. Give Mel a call at 480.274.7000 if you have any questions.