In change of ownership transactions, Sellers may agree to finance a portion of the purchase price through the use of a promissory note (“Seller Note”). Seller financing reduces the amount of the bank financing and thus reduces the risk to the Lender. A Seller Note also allows Borrower to retain greater liquidity and pay less cash up front. When Sellers are involved in an SBA loan transaction as a junior creditor, there are several additional considerations for Lender, as the senior creditor.
SBA requires that a Lender document the terms of the Seller Note (e.g. interest rate, maturity date, any standby period, etc.) in its underwriting to make sure Borrower can still demonstrate repayment ability when the Seller Note payments are considered in Borrower’s cash flow analysis. Lender will also need to understand and consider whether the Seller Note will be secured with a guaranty, lien on the Borrower’s business personal property or real estate, a collateral assignment of life insurance, etc. The Lender should work closely with its counsel and with title agents, as applicable, to make sure that the Lender’s UCC financing statement, mortgage or deed of trust, and other collateral documents are perfected prior to Seller’s collateral documents.
Lender will also want to obtain an intercreditor and subordination agreement signed by the Seller. Lender may use its own form or SBA Form 155 Standby Creditor’s Agreement (“Standby Agreement”), but whatever form Lender chooses to use, the Standby Agreement should address the following items:
Lenders should also require that the Seller Note contain language acknowledging that the Seller Note is subject to the terms of the Standby Agreement. Thus, if the Seller Note is ever sold or assigned, such purchaser or assignee of the Seller Note will be put on notice of the Standby Agreement, making it easier for Lender to enforce the terms of the Standby Agreement against the purchaser or assignee, if necessary.
Because Standby Agreements can be highly negotiated, it is important to circulate the Standby Agreement to Seller and Seller’s counsel as early as possible in the closing process so that negotiations do not delay the closing or cause the deal to crumble.
By understanding the SBA requirements in relation to Standby Agreements and seller financing, Lenders will be in a better position to avoid repairs or denials of the SBA guaranty. For questions regarding Standby Agreements, contact the attorneys at Starfield & Smith at 215-542-7070 or email us at info@starfieldsmith.com.
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