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Action Academy | Millionaire Mentorship For Your Life & Business
How / When To Negotiate SELLER FINANCING When Buying Your First Small Business
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What's up guys? Welcome back to another episode of the Action Academy podcast, Corporate America's least favorite podcast. Guys and girls, I want to give you guys a quick update which is possibly one of the coolest of our Action Academy community, our backend mastermind of the podcast. I am on the tail end of completing 84 separate in depth trainings from every single stage and process of the buyer's journey. Going through acquisition of your first small business from I have no idea what a small business is or how to get a loan for one all the way to the closing table and what to do the 90 days afterwards. And so I've spent 47 hours now directly scripting and recording each one of these lessons, each one of these trainings. And I decided over the next couple of weeks I'm going to do about one training per week live on the podcast for free to all of you guys so that you can get a glimpse of the information and the education that is within our Action Academy community. As always, if you're looking to buy your first cash flow in business this year, go to actionacademy.com or click the link in the show description. It will take you to our team. Now let's get to the training. This module is going to be a little hairy and think of it like another tool in your tool belt. Give yourself some grace as you're going through this process. You're going to get more familiar with all the different terms, all the different ways to leverage things, especially when you're submitting offers and you're in the offer stage. We'll talk about this stuff a lot more, but I want to go ahead and get your toe dipped into the pool here so that you can understand at least the terms. And so when people are dropping these terms on you, you're not like, huh? And looking into chat GPT to come up with the answers. Okay, so this is going to be seller financing and creative structures. Okay, this is going to be basically a one on one. This is going to get your, your toe dipped in the pool like I said. So this will get you in the, in the shallow end of the pool and we'll talk a little bit more when it's come to actually like loi and offer structures for you to understand a little bit more in depth. So what we're going to be covering here is what seller finances is and when it shows up and key terms. You need to know how seller financing works alongside sba. When seller financing is the entire deal with no SBA creative structures, you're going to encounter and why you don't need to master this now, just recognize it. Okay, so this is a pretty advanced module. If you're on the standard SBA path, you may never need to structure a seller finances deal from scratch. But seller financing shows up in enough deals. You need to recognize the terms when you see them and understand what they mean. So think of this module as like learning the stuff. So when a broker says things like the seller will carry a note or, or there's an earnout component or the notes on standby, you need to know what this stuff means so that you can walk the walk, talk the talk, if that makes sense. So we're gonna go way deeper on structuring and negotiating terms in stage six, the offer. But for right now, here's some of the language. Okay, so what seller financing is, is it means that seller lets you pay a part or the entirety of the purchase price over time instead of all at closing. So instead of getting one check for the full amount on closing day, it's gonna be spread out over an agreed amount greed period. Most of the time it's monthly, not quarterly, but monthly. So you're gonna negotiate the price, duration and terms. Okay, so it's gonna be what's the price? How long are you paying this price and what are the terms? Like what's the interest rate, what's the balloon? We'll cover what a balloon is here shortly. So the seller is acting as your lender for that portion of the deal. You owe them money, you make payments, the seller becomes the bank. Same thing in real estate. So why sellers agree to this tax benefits. So, and I'll even bold this, so if the seller receives a million bucks through the SBA when they close through the sba, they're just going to get all that money in cash. They're going to pay, like I said, 32 to 37% in taxes. Okay, so if you spread payments over five years, they spread the tax hit. So for many sellers, this saves them a significant amount of taxes, getting the deal done. If you're 50k short on the purchase price and the seller can carry a note to bridge the gap, it's better than losing the deal alignment. A seller who carries a note wants you to succeed. If the business fails and you stop paying, they lose money. So they're more likely to help with the transition, answer your calls and genuine support you. That's why we always want to structure at least 5 to 10% seller carry term that you're going to be learning Inside a business deal alongside a SBA just for that. Like, you want them to have aligned interest so that when you're six months deep into the transition and you need to call them, they'll actually pick up the phone. Okay. And a faster close. If you do a full seller finance deal, you can close significantly faster because there's no banks involved. Okay. Terms you need to know. Seller note, that's what we're talking about. The formal IOU from you to the seller. It's a promissory note. You can get this from a legal professional. But this one is not too difficult. Of a document like two to three page documents, not that difficult. Okay. So all it's gonna say is how much you owe, the interest rate, payment schedule, what happens if you don't pay? Your attorney drafts reviews. This. Never sign a legal. A seller note without legal review subordination. Again, you're not gonna really hear this word too, too much. But it's good to know what this means. So when your deal has an SBA loan and a seller note, the SBA loan is what's called senior to the seller note. So the seller note is subordinate. The seller gets paid after the bank. So what this means is it's just like the bank's the primary debt. Again, when we were going through the capital sack, it's the base layer of debt, and then this is another layer of debt on top of it. Standby, you're going to use this a lot. You're going to hear this a lot. Standby and earn out. You're going to hear a lot. So a seller note on standby means the seller receives no payments, no principal, no interest for a defined period. Full standby means no payment for the entire term of the SBA loan, typically 10 years. Partial standby might mean no payments for the first two to three years, but then payments begin. Why standby matters. Let me make that bold. So under this 2025 SBA change, a seller note only counts towards your injection requirement if it's on full standby for the entire loan. So let me just make this super easy for you before. What you could do is you could use a seller note 10% to cover the down payment of the business that no longer flies. You still need to bring, or you and a capital partner need to bring 10% down. And so the SB crack down on this. So essentially, no, all this is saying in this, in this document right here in this paragraph, saying that you can't be able to use a seller to give you 10% down through seller financing. So you can still get 10% down. You just can't use it as your down payment. Does that make sense? Still can get 10% seller fi, just not as your down payment. That's all this means. But so how standby works is you can use this to be able to help when you have business expenses that are going crazy through a transition period and it may be a little bit of a dip in the beginning and then it's going to pick up later. That's where we can use standby to where that payment kicks in a little bit later. Or you'll do payments what are called interest only. So this is all stuff that you can negotiate and we'll do way more modules on this later on. This is just the 101 version. So an earn out, this is the best defensive metric you can use. If you can get an earn out on a deal, that's wonderful. The less competition you're facing on a deal, the more likely you can throw an earn out in. If you're super, super deep in competition on a deal and you have multiple Lois, the broker's like, dude, this is a competitive deal. You're probably just not going to get an earn out. So what an earnout is is a portion of the business price that's based on that's paid based on the business's future performance. So instead of agreeing to a flat purchase price, you're going to hold back some of that money contingent on results. So an example purchase price, 900k at closing plus a hundred k on standby or earnout if the business maintains 300k SDE for the first 12 months post close. So why they exist is they bridge a gap when the buyer and seller disagree on value. The seller thinks the business is worth a million bucks, you think it's worth 900. And earn out says, let's agree on 900k now. And if the business performs the way you say it will, you'll get the extra a hundred. The only time that earnouts really work is if it's that higher purchase. So if you're like, dude, this doesn't make any sense. But I'll tell you what, I'll give you the price that you want, but it's going to be off of my terms. Okay, so it's either, it's either your terms my price or your price, my terms. And so if we're giving them the price they want and they're like hell bent on 1.2 million, like, all right, well, I think it's worth 900k. I'll give you your 1.2 million with a 300k earnout contingent on this, this and this. Does that make sense? So then the seller has to actually perform this thing. The business has to actually perform to up to that standard for you to be able to get that earn out. And then you can structure how the earnout's paid. So earnouts align incentives. The seller gets rewarded if their claims prove true. But they also create complexity. So there's a bunch of stuff here. This is where we do not have vague language and this is where we're utilizing legal professionals again. And then last one's a performance based seller note. Last. Well, couple here. So similar to an earnout but structured as an adjustment to the seller note. If a business underperforms a defined threshold in, in year one, the seller note balance gets reduced. So this is kind of the opposite. So seller carries a hundred k note. If SDE drops beneath below 250k in year one, the note balance reduces by the shortfall amount. So let's say that the SDE is only 200k. Okay, so this would reduce this a hundred k note by $50,000. Does that make sense? It's another defensive metric that we can put. So this protects you if the seller overstated the business's performance, which we can just go ahead and assume is always going to happen, period. So not all sellers will agree to this. But if you guys are in communication, you've got a good relationship. This is why a good relationship matters. So that you can have this type of negotiation with the seller. And you're like, look, I want to do the deal, you want to do a deal. And it's a little bit of a give and take. So this is a dance. So you're giving them something and asking for something in return. You never just give the seller what they want. All the time. You, you give a little, you ask a little, you give a little, you ask a little. So again, going back to the earn out, hey, you want 1.2? I'll give you 1.2. Here's what I want in return. I want 300k of that as an earn out. It's going to be paid 24 months later contingent on business hit and all this. If you say what you say you're it is and the business is accurate, there should be no sweat. You're going to get your money. But I want to make sure to cover my ass here. Transition consulting agreement. So you can do a consulting agreement too. So the seller stays on for a period after closing 30 days to 12 months. It's a paid consultant. They separate from purchase price. Okay, I'm going to give you the textbook answer. I'm going to give you my answer. Textbook answer. This is often smart sellers. Knowledge about customers, vendors, employees and operations is valuable during transition. My answer is the back half of the paragraph. You don't want a seller hanging around indefinitely thinking they still run the place. So if you do have a TCA here, which is another document, you want to make sure it's defined by like a remote phone call or a zoom call, like they can't be on site. Because what's going to happen is if the seller is still hanging around, it's like an ex girlfriend hanging around. Nobody's. Everyone's confused. Like they're like. Or like a divorced parent, like, do I listen to mom or do I listen to dad? Like, which one do I listen to? And it's so confusing. So if the seller is actually like there all the time helping you with things, it's gonna be so confusing. Like you're not gonna become the boss, like, period. So the only way that this really works is if you're like, hey, I'm gonna call you once a month for the next 12 months and you have some type of agreement. Or you could just structure that in your seller finance note. Okay? Then the last term you need to do is a balloon payment. So this is the payment structure where you make small monthly payments for a period, then you owe the entire remaining balance in one lump sum at the end. So an example is a 100k seller note, interest only payments for 5 years. Then the full 100k is due all at once. So this is anytime you get interest only, it's a smaller payment and it helps you with the debt. Right. The dscr, which is the ultimate metric we're looking for here, is for every dollar of profit, how much, how many cents of that, what percentage of that goes to debt pay down? So we do what's called interest only payments. And so a lot of the times sellers will do an interest only payment with the balloon, but that's the stipulation with the balloon. So this is also making sure that they get all of their payments due when it's due, but you're not paying it all up front. So this gives you a little bit of time to get the business stabilized so that in the back end you do have to make sure you have that frigging cash sitting there because your balloon payments come in due. Okay. So balloons are risky. If you can't pay a refinance when the balloon comes due. The seller can come after the business with the seller proposes a balloon. Make sure you have a plan. Either save for it, refinance, or negotiate it. What I highly, highly, highly, highly, highly recommend doing is if you do have a balloon payment while you are making these small monthly payments for a period, tack on 20 to 40% of that payment, put it into a bank account, and have it built up over time, almost like you're making a double payment to the seller. Even though that's not technically a debt payment, it is a savings account that you're putting, putting that money in, maybe a high yield Savings account earning 4% interest, where you can build that up over the next couple of years and have that presented to the seller as the balloon payment. That's what I would do with the balloon. That's the responsible way to do it. Or you can just sit around and wait for your business to hopefully do millions more dollars in profit and then just take it from there. Your choice. How seller financing typically shows up. The most common scenario is it's a small piece of the capital stack, not the whole thing, which is we've done full seller finance deals. They exist for sure, but this is most likely what you're going to see. SBA loan, 85% year injection, seller note again, second layer of the debt. Total project costs million bucks. Seller carries 50 to 100 grand, pay them monthly over 5 years, 6% interest. This is purely negotiable. You can make it whatever interest works. The way that you negotiate the interest rates is you don't just pull them out of thin air. You just say, this is the debt that I can afford and this is the monthly payment that I can afford. And then you just pull the levers on the duration and interest rate until you get to that monthly payment. That's how the math works. So the SBA loan is senior and then what's the seller note? Subordinate. Right? Yay. We learned. So you model this in your acquisition math. Okay, so SBA minus SBA debt service minus seller note payments minus capital partner return equals your take home. So these are just tranches of debt, just layers of debt that you're adding on and eventually you pay them all off and then you're free and clear. Yay. So when seller finance, when seller financing is the entire deal, sometimes SBA isn't an option. We have some Action Academy members that aren't US Residents, so screw this business too small. Don't do that. Deal the books are too messy. Don't do that deal. Seller wants a fast close. Don't do that deal. What you're going to do that deal is you're just not SBA eligible, which means you're Canadian, Mexican, or you're just not a US citizen. So what happens is now you're gonna put down still probably 10%, sometimes less. If you've got a great relationship with the seller, you're still gonna put 10, 10%, but now you're just gonna make the terms down payment, interest rate, payment schedule length, or whatever you and the seller agree to. There's no playbook here. There's no rules. It's literally the wild west. So the advantage here is speed and flexibility. No banks, no SBA. You can close in 30 days, you can do whatever you want, but the risk is less protection. So SBA deals come with built in structure lenders. A lender won't fund a bad deal, which actually protects you. So there's a lot of red tape and paperwork, but it protects you in the long run. So in a pure seller finance deal, it's the wild west. There's no lender saying this doesn't make sense. And so if you evaluate this deal correctly, your quality of earnings report and your attorney become even more important than ever. I'm literally going to highlight it like, because you're not going to have the banks helping you underwrite this stuff. So this is where your attorney and Q of you really comes into play. When to walk away. If the deal requires more than two creative elements to work. Seller note plus earn out plus consulting agreement plus deferred to payments. It's too complex. Complexity creates conflict. The simplest structure you want to do is always the best one. If you can't explain the deal structure to your coach in two minutes, it's too complex. Simplified our pass. So in closing, common mistakes. Think you needed to master seller financing before entering deal flow? No, not really. You just need to know. Earnouts, seller notes, transition consulting agreements, standby. That's all you really know. And then interest only. Balloons. Agreeing to terms you don't understand. If a broker or seller uses a term you don't understand, stop and ask. Don't act like you're so smart, just ask. Agreeing to a balloon payment without a clear plan to pay it. Using creative structures to make a bad deal work. Don't do it. Not having your attorney review seller financing terms? Hell no. It's still a legal contract. You want your return, you want your attorney to review it. So now you know the vocab seller note, subordinate standby earnouts, performance based consulting agreements, balloons. You don't need to be an expert, but at least you have a. Like I said, you're in the shallow end of the pool. So what's next is module number 25, alternative capital. This is going to be real. Real. This is Rob's 400 investors, the last advanced module in the capital stack. And then we're going to get into deal flow.