Sellers: 12 ways to minimize exposure on the  unsecured loan

 

 

If part of the purchase price is secured by an SBA loan, the Seller can employ the following strategies to minimize exposure on the  unsecured loan (for example $200,000):

1. Obtain a Personal Guarantee from the Buyer

  • Require the Buyer to personally guarantee the $200,000 unsecured loan, making them personally liable if the business cannot meet its obligations.
  • This adds an extra layer of accountability and reduces the Seller’s risk in case the business fails or defaults.

2. Secure a Secondary Position

  • While the $200,000 loan is “unsecured,” the Seller can negotiate for a second lien position on the business assets after the SBA loan. This ensures some recourse if the Buyer defaults, even if the SBA loan has priority.

3. Establish an Escrow Fund

  • Require the Buyer to place a portion of the cash payment (or another agreed-upon amount) in an escrow account to act as a reserve for potential payment defaults on the $200,000 loan.
  • The escrow account can release funds in installments based on the Buyer’s compliance with payment terms.

4. Accelerate Payment Terms

  • Instead of a single balloon payment at the 10-year mark, negotiate periodic principal and interest payments (e.g., quarterly or annual installments) to reduce the unpaid balance over time.
  • This reduces the Seller’s exposure to the full $200,000 for the entire term of the note.

5. Include Default Protections

  • Add provisions to the note allowing for immediate acceleration of the loan (i.e., full payment becomes due) if the Buyer defaults on the SBA loan, fails to maintain the business, or breaches other contractual terms.
  • This incentivizes the Buyer to prioritize repayment of the Seller’s loan.

6. Restrict Distributions or Dividends

  • Include a covenant that prohibits the Buyer from taking excessive distributions, dividends, or other cash outflows from the business until the Seller’s loan is repaid.
  • This ensures the business retains adequate cash flow to service its debt.

7. Negotiate Higher Interest Rates or Fees

  • Compensate for the risk of the unsecured loan by negotiating a higher interest rate or including upfront fees to improve the Seller’s return.

8. Review Buyer’s Financials and Creditworthiness

  • Conduct due diligence on the Buyer’s financial stability and credit history to assess their ability to repay the unsecured portion of the loan.
  • Use this information to negotiate stricter terms if needed.

9. Include Cross-Default Provisions

  • Tie the unsecured loan repayment to the SBA loan. For example, if the Buyer defaults on the SBA loan, it would trigger a default on the Seller’s loan as well.

10. Use a Third-Party Guarantee

  • Consider requiring a guarantor with strong financial backing to secure the $200,000 note. This could be an investor, business partner, or other creditworthy party associated with the Buyer.

11. Require Key-Person Insurance

  • Require the Buyer to maintain a key-person life insurance policy with the Seller listed as the beneficiary. If the Buyer becomes incapacitated or dies, the insurance proceeds can cover the unsecured loan.

12. Monitor Business Operations

  • Negotiate a right to receive regular financial reports or conduct periodic audits of the Buyer’s business. This allows the Seller to monitor the financial health of the business and take proactive measures if signs of trouble appear.