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As the secondary market surges ahead into the age of the internet, E-Commerce and computer EVERYTHING, we receive a lot of requests to consider business notes secured by industries and service related companies involved in varying facets of the cyber world. Historically most business notes were created through the sale of a retail outlet, manufacturing business, service industry, etc., businesses with something tangible that could be foreclosed on.
However, we are seeing more and more service related businesses LIKE a Dot Com that come with little to no security in the form of hard assets. Still, as has been the case for a decade in the business note arena, many of the same issues that concerned us on a “Ma and Pa” business note in the pre E-Commerce era are still a major concern today as we evaluate a business note, corporate buyout, merger and acquisitions, etc., such as:
Longevity in Business
How long a business has been open and operating speaks volumes about its potential to be around AT LEAST as long as there are payments remaining on the note. A strong pay history tells us that he is obviously comfortable with the business and knows what he’s doing. A business, ANY business that has recently opened its doors has yet to generate a loyal clientele. There’s no telling whether or not the concept will be accepted by the consuming public. The “Dot Com” blood bath is a good example. Still not convinced? Attend a Silicon Valley “Pink Slip” party and talk to the thousands of unemployed that thought they had it made just months before. “Boomers” driving “Beemers” now arrive on Go-Peds.
Generally we like the business to have about three to four years of operating history. We can review its corporate tax returns for the two to three years prior to the sale and ascertain if it was a profitable venture or if the Buyer took over a sinking ship. This is even more crucial in any hospitality industry notes (restaurants, deli’s, bars, etc) where word of one bad meal can spread like a wild fire killing any hopes of success.
Business type/Collateral Security
Different business types come with a variety (or lack thereof) of collateral securing the note. While we appreciate that in the event of a default the “stuff” securing the note will be worth pennies on the dollar at a local auction house anyway, we still like to review notes with SOME level of tangible, foreclosable chattels as security. An e-commerce business likely has little to no assets other than a few used computers and a couple phone lines. In many cases even e-commerce businesses that actually HAVE a product keep very little in inventory, ordering on an as needed basis. Many of you may remember the on line auto insurance company business note that circulated for almost a year before disappearing. We saw it two to three times a day at one point…it was really being shopped. The seller boasted that the new business was sure to explode, that the buyer got in with little down, there was no inventory involved or required and he was working it out of his spare bedroom. Wonder if he noticed his toes disappearing as he kept shooting himself in the foot?
Professional businesses like Doctors, Chiropractors, Attorneys, etc. are okay, assuming we have a comfort level with the Buyer, and they’re experienced in the business in question. A seasoned, veteran Doctor who patients have been with him for years may not approve of the new, young intern that just bought “Doc Brown’s” practice. That could kill the business before he gets a chance to prove himself. There goes the note. So a little seasoning would speak volumes about the strength of the note.
Businesses with little to no collateral must have some other mitigating factor to entice us to consider it for acquisition. That leads us to our next point which is:
Payor Financial Strength/Equity/Credit History
A buyer that contributes a sizable cash down payment tells us that there’s a good chance they did a lot of research on the business, that they have confidence in their ability to operate the business successfully, may have experience in this TYPE of business and that they have a serious monetary (as well as psychological) investment in the business and it’s success. BUILT UP equity (through pay history and seasoning) is not the same. THE BUSINESS makes the monthly payments, it really doesn’t come out of pocket. A buyer that gets in with little to no down can run the business for a year or two, develop financial trouble and say to himself, “well, it was a nice run, I paid myself a nice salary, made some money but now its over”. All he has to lose is his credit record which, unfortunately, too many people these days could care less about. As you’ll see at our web site (www.nationalcapitalcorp.com) there are minimum cash down payment requirements for these high risk notes.
Also keep in mind that “Credit” is not an indication of financial strength. An immigrant in this country for three months can have a high credit score but own nothing. We implore business brokers to make personal Financial Statements part of the qualifying process for their selling clients. A buyer is not obligated to provide one piece of information about himself just because the seller now wants to sell the note. The same goes for the financial status of the business in question. We advise sellers and their brokers to include a clause in the Purchase and Sale Agreement for the business that the seller can request year to date P&L’s at least twice a year. While this is a great way for the note holder to protect his investment and possibly see signs of things to come if the Buyer is having trouble, most balk at the idea or feel they will be “imposing” on the Buyer. Unbelievable. The Buyer owes you thousands of dollars and protecting your investment is imposing?
Business Assets: The business must have serious, tangible, liquid assets. While we prefer to be in a perfected first lien position we’ll occasionally accept a Junior position depending on the size of the Payor’s company and their financial strength. Hopefully the business has a Dunn and Bradstreet number we can review. Last couple years of corporate tax returns and year end P&L’s will be required as well. We need to ensure the Payor is strong and that they are not heading in the wrong direction.
All in all the face of the Business Note arena is changing in ways that provide increased opportunities for the savvy broker. HOWEVER, as has been the case for years, maximizing your efforts and profit potential hinges on your explaining to your clients HOW the game is played, what the underwriting criteria will be and most importantly, how SIGNIFICANT the discounts can be. A full will ALWAYS be the worst way for a seller to go. Persuading your clients to look at the creative “options” you (through us) can provide and then zeroing in on their IMMEDIATE cash requirements will increase both your kill ratio and bank account.
Source: NationalCapitalCorp.com

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