Seller financing is a common way to sell a business. With seller financing, the buyer of the business gives a promissory note to the seller, promising to repay them some part of the purchase price over time. A business is typically sold via an asset purchase agreement (“APA”), which specifies the price and terms of payment.
With seller financing, the seller can sell their business and receive payment (the business’s income) over time. Seller financing sometimes becomes necessary if the buyer does not have the full purchase price or cannot get a business loan.
Should a seller self-finance the sale of their business? In short, not if it can be avoided, but it may frequently be necessary. When the seller self-finances by accepting a promissory note from the seller, there are three things that can be done to ensure the seller’s interest in payment is protected: 1) get a personal guaranty, 2) get a lien on the business’s assets, and 3) research the buyer.
Get a Personal Guaranty for the Business Purchase Price
The first thing a seller should do to protect themself if they are accepting a note for the business is to get a personal guaranty from the buyer. Buyers usually purchase a business using an LLC or a corporation, and this business entity is usually the one who signs the promissory note. These entities may be brand-new and have little or no value, however – therefore, the seller should require the buyer to personally guarantee the amount due, putting the seller’s own house, assets, bank accounts, and so on, on the line. This will mean that if the buyer defaults, the seller can file a lawsuit or seize assets to ensure payment for the seller’s business.
Put Liens on the Business to Ensure Payment
The second thing a seller should do to protect themself is to get a lien on the property. If the seller of the business has sold real estate as part of the asset purchase agreement, they can put a deed of trust (mortgage) on the property. Or, if there is no real estate, then the seller can file a UCC lien on the assets of the business, such as machinery, accounts receivable, and cash. In the event the buyer fails to make payments on time, the seller has a higher right to payment than other creditors.
Background Research on the Buyer
The most important thing a seller can do, though, is to investigate the buyer thoroughly to try to ensure you won’t need to use the guaranty or the lien. Search for lawsuits, liens, and other public records that indicate whether the buyer pays their bills on time. If there is a string of judgments and unpaid debts, the seller will have to stand in line to get paid. But if there’s a clean record, and if the seller’s finances otherwise appear to be in good standing, then there is a good chance the seller will pay as promised.
Dye Culik PC is a Charlotte, North Carolina law firm handling business law, mergers and acquisitions, and asset purchases throughout North Carolina. If you are buying or selling a business, contact us for assistance guiding you through the process.