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What Is A Business Note?

By Robert Duplicki      Updated November 28, 2023

A business note is a group of documents used to formalize the sale of a business, when the seller receives some of the purchase price in installments.

The images above are examples of the documents comprising a business note. You may click or tap on them for complete documents.These examples are only for illustrative purposes, and actual documents could vary substantially based on individual circumstances.

Consider The Analogy Of A Real Estate Note

A real estate note is used in the sale of both residential and commercial property. The note is typically used in conjunction with a mortgage or deed of trust. In the cash flow industry the word “note” is used in reference to both documents together, and as the legal document itself known as a "Note." The real estate note is a secured promissory note. It is secured by the property.

The note is the document which conveys the promise to pay for the real estate. The mortgage or deed of trust is the document which shows the collateral for the note. Unlike a mortgage or deed of trust, notes are not recorded.

A business note is the equivalent of the real estate note described above, but used for the sale of a business.

An Auto Loan Provides An Introductory Example

I have an old auto loan document which is a Promissory Note. You may be familiar with an auto loan, and I think that it provides a good example of how a business note gets structured. At the top of the note the name and address of both the borrower and lender are listed. There is also some information included for the lender's use only which does not limit the terms of the note. Next the note shows the Principal Amount,interest rate and date of the note.

What follows are paragraphs conveying each of the following terms of the note: Promise To Pay, Payment, Prepayment, Default, Lender's Rights, Right Of Setoff, Collateral, Waiver By Lender, Waiver, Assignment, Customer Information, Disclosure Statement, General Provisions, and a statement that the borrower has "read and understood all the provisions of the note." The promissory note then concludes with the borrower's signature.

To further understand the operation of a promissory note I will quote the definition of two of these key terms. The first is Promise To Pay. The note states: "To repay my loan, I promise to pay to PNC Bank,FSB ("Lender"), or order, in lawful money of the United States of America, the principal amount of Twenty Five Thousand & 00/100 Dollars ($25,000.00) together with interest at the rate of 8.490% per annum on the unpaid principal balance from the date funds are advanced, until paid in full."

So whether we consider an auto loan promissory note, a real estate note, or a business note, the essential element is the promise to pay a specified some of money for an asset according to the terms of the note.

The second key term is Collateral. In this auto loan example the promissory note states: "The Note is secured by the Property described in the Consumer Security Agreement. If there is any inconsistency between the terms and conditions of the Note and the terms and conditions of the collateral documents, the terms and conditions of the Note shall prevail."

Each of the examples I am referencing are secured notes. That means that the promise to pay, (the Note), is secured by collateral. And there is a separate document having varying names, that provides the description and agreed upon terms of the collateral. The Note will refer to the specific security agreement that applies.

Keep in mind that this auto loan promissory note comes from a bank loan. Most business notes discussed on this website are made between the business seller and the buyer of the business. They will agree on the terms of the note and typically use professional resources such as an attorney to prepare the actual documents.

A Business Note Is Not A Commercial Real Estate Note

While the owners of some businesses own the real estate that the business occupies, from the perspective of a note investor, a business note does not include the real estate. The real estate is best handled in a separate note. A business note that includes real estate is known as a hybrid.

The sale of a business apart from any real estate, includes furniture, fixtures, equipment, inventory, accounts receivable, intellectual property and good will.

When a business is sold using seller financing, the main documents are the Purchase And Sale Agreement, Promissory Note, Uniform Commercial Code Financing Statement(UCC-1) and Chattel Security Agreement. As mentioned, terminology used may vary considerably depending on your circumstances, location and source of documents.

In the illustrations above, the purchase and sale agreement used is an Asset Purchase Agreement. This format is used when an asset sale takes place as opposed to a stock sale. Assets both included and excluded from a sale will be listed.

The Promissory Note in essence is the business note. It is the promise to pay between the named buyer and seller a specified amount of money according to the terms of the note. Promissory notes are governed by Article 3 of the Uniform Commercial Code (the "UCC").

The Chattel Security Agreement lists the items that provide security for the note. By executing this agreement the business seller places a lien on the business assets that were sold.

A Uniform Commercial Code Financing Statement(UCC-1) is the document used to record the seller's lien against the business and its assets. UCC-1's are recorded with the Secretary of State.

Promissory notes are negotiable instruments and may be sold for cash. A full sale of the note or a partial sale in various arrangements is allowed. That is, all the remaining installments of the note may be sold, or different options of fractional sales. Whenever you feel that such a cash infusion would help, you can begin the process by completing one of my worksheets. I will work with you to maximize the cash you receive based on your needs.

What Is A UCC-1 Blanket Lien ?

A Uniform Commercial Code Financing Statement (UCC-1) was mentioned above. In business financing this document is used to file a lien against property being used to secure the transaction (collateral). A blanket lien uses all the business's assets as collateral, as opposed to a specific lien which lists only one or more individual assets as collateral. The amount of the lien is limited to the amount of the loan.

This topic is really associated with business lending during the course of running a business, as opposed to a business note used to finance the sale of a business. A common example is a business loan used to purchase equipment. Unless you are in a position to get an unsecured loan, the equipment loan would typically use the equipment to secured the loan. But the lender may feel the need for additional collateal and then would place a blanket lien on your business assets.

A blanket lien brings some concerns with it. The lien will become part of your business credit history and may reduce your credit score. A default on the loan would of course have a greater negative impact. But even if you are making timely payments on the loan, a blanket lien could hamper or prevent you from obtaining additional business financing since there is a lien on all your business assets. So this is something to keep in mind as you negotiate loan terms.

Looking ahead, one further concern to consider, is what will be the status of a blanket lien should you decide to sell your business. For more information about UCC-1 Blanket Liens, take a look at How Can A UCC-1 Blanket Lien Affect Your Business?

Helpful Ideas About Business Notes

  • A business note presents an opportunity to sell a business, and gives the business seller the opportunity to sell the note or part of it for cash. Whether you sell the note or not, first you receive a down payment, followed by periodic payments which should be at a favorable rate of interest. Knowing the difficulty small business buyers have to obtain bank financing, it helps to deal with this reality early on and make the most of it.

  • As you consider the criteria suggested or required by note buyers and brokers, these criteria also offer recommendations of how to structure the sale of your business. Whether or not you will consider selling the note, it is essential that the way the note is structured is affordable to the buyer of the business. While this may make the note less desirable to note buyers, you have to prioritize. A less desirable note may still be saleable, but at a greater discount.

  • In keeping with note buyer criteria, the higher the down payment, the better the note. In researching this topic you will find minimum down payment criteria of 20%, 25%, and 30%. So different buyers/brokers who say they are the best buyer for you, may not be the best source for you if their opitions are limited.

  • The higher the interest rate the better. One online source indicates a minimum of 12% as of the writing of that article. Of course that article is not dated. What is affordable will depend on your situation including the sales price, the other terms, and expected cash flow.

  • The higher the credit score of the business buyer, the more attractive will be the corresponding business note. Note buyers will have a variety of minimum acceptable FICO scores. The business seller should definitely check the credit history in advance. But a business note is still made up of all the other factors. The overall credit history and the direction it is moving are more important than the credit score, as long as your buyer is well qualified to run a profitable business.

  • It follows that a desirable business note has a history of on time payments that are well documented.

  • Note buyers prefer business notes with a short term that are fully amortized. 72 months is a good rule of thumb. By saying fully amortized, that means no balloon payments are preferred. But not all note buyers are as concerned about this. Of course the shorter the term, the larger the periodic payments. How well can the business buyer handle those larger payments? A balloon payment may be necessary to make the note work. The concern is how will the balloon payment be made. There could be a need to extend the note at a later date. As partial sales of business notes are more common than full sales, that's one way to help deal with this set of challenges.

  • A business note that has been seasoned is a common requirement to sell the note. That usually means that at least three payments have been made on the note.

  • If the business is purchased in a corporate name or LLC a personal guarantee is required within the business note. The strength of the guarantee will vary based on the wording used. By comparison, the Small Business Administration requires an unlimited personal guarantee.

  • All things considered, the definition of a high quality business note includes many components. In creating your business note I suggest that you combine the pertinent concepts in a way that works best for you according to your priorities.

For more helpful information about business notes refer to Make Your Business Notes Profitable.

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