I recently received a request for a quote on a business note. The note seller was surprised that selling a business note has different criteria than a real estate note. Maybe it is time to revisit the do's and don'ts of business notes. The following was taken from an article from December 2004 of the Note Professor Newsletter. Hopefully it will aid any who are considering selling their business utilizing seller financing.

The Business of Business Notes

This past month I have received several calls from people wanting to sell their business, carry back a note, then sell their note at closing, or shortly after. They are then appalled at discovering it is easier to swim Lake Superior with rocks on their backs than to sell a business note at closing, and when the note is sold, there is a deeper discount than discounts on real estate notes. In this issue I am going to give the nutshell version of business notes; what you can expect, and what not to expect.

First of all remember that when selling a business, especially without real estate, and taking back a note, the collateral is not nearly as secure as with real estate. For example, when a restaurant is sold, an amount is given to all the equipment. Anybody in the business knows there is a big difference when you buy a stainless steel sink, and when you try to sell one. Because used equipment does not offer much security for the note, the ability of the business and the skills of buyer to generate a cash flow that will support the debt payment, as well as SUPPORT THE OWNER, are the main factors that determine a good business note. Be ready to supply information on the cash flow of the business, and the experience of the payor if you plan on selling a business note.

Also, remember that "goodwill" cannot be used as collateral in small businesses, but it is often the major value in the price of the business. Combine this with the ever increasing bankruptcies, and you can tell that business notes are much riskier than are real estate notes. For example, if I purchase a real estate note, where the collateral is a house valued at $100,000, and the payors do not make the payments, I can foreclose with the knowledge that I have $100,000 collateral. But with business notes used equipment or good will are not good security, therefore the discount is going to be steeper; much steeper.

Along the same lines, where 10% down with 30 years to pay on a owner occupied house is sufficient to a note buyer, this is not the case with a business note. To have a marketable business note, 30% down with 5 years to pay is a good standard. Think about this, whether you are selling your business note, or you are going to keep it. If the buyer has virtually nothing into the deal, with the only collateral being used equipment, what security is there for the note? Not much, is there?

Last, is the issue of simultaneous closings. Because there are often "gentlemen's" agreements or oral promises with the sale of a business, it is standard to have AT LEAST 6 months of seasoning. This gives the new owner the opportunity to see that all the equipment is working, and there are no "surprises", making sure the new owner is satisfied with the sale. Business note buyers will insist the new owner be in the business for a period of time before risking their money to purchase a business note. So if you are planning on selling your business and taking back a note, do not expect to get 90% of face value that you might get with a real estate note. Here is a good "nutshell" summary of what to expect when selling a business note.

1. Minimum of 30% equity
2. Six months of seasoning
3. Good credit of payor at the time of note purchase (650+)
4. Expect a discount to give the note buyer a 14% to 20% yield (Yes, this is high compared to real estate notes, but the risk is greater, is it not?) Use your calculator to determine the discount.
5. Length of note not to exceed 72 months (If longer, be prepared for a partial offer)
6. Note to be fully amortized i.e. no balloons. If there are balloons, be prepared for a partial offer.
7. Personal guarantee of payor. (Corporate signatures will not cut it)
8. Proof the business and buyer are capable of paying the debt service. (Be prepared to show the IRS information and P&L. "Hiding" income is not going to fly with a note buyer.
9. First lien against all assets. UCC 1 filings.
There is other due diligence that the note buyer will perform, but this will give you an idea of what you are up against when trying to sell your business note.

Remember, since the collateral is more risky, this risk will be reflected in the discount.

If you have any questions or comments, be sure to contact me In the subject line, write ASK the PROFESSOR.

Remember, if you know of someone who has a note to sell, I will pay referral fees at the least, and will also split my profits if you would like to "co broker" a Note with me.

I have a Get a Note Quote web page that can be filled out and submitted for professional pricing. Check it out.

Tom Henderson /a.k.a. THE NOTE PROFESSOR .

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By popular demand, THE NOTE PROFESSOR NOTEBOOK is now available in easy, downloadable E- book form for a the low, affordable price of $39.95. Other products are also available, including HOW TO MAKE OBSCENE PROFITS with SMALL MONEY, and GUIDE FOR SECOND LIENS. There is also a FREE download of CHECK LIST FOR OWNER FINANCING. Simply go to the NOTE BUYERS STORE. I can think of nowhere that you can find such information packed products at such incredibly low prices. We are still working out the bugs, so if you have any problems, be sure to contact me.

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Current ARCHIVES (end of 2009-2012)

Last week I heard a few pundits, both Democrats and Republicans, tout Keynesian economics by name as the proper method of getting us out of our economic turmoil. At the same time, I received an email wanting me to explain Keynesian economics. I will do my best, but bear in mind explaining Keynesian economics in a short newsletter forum is not an easy task.

Keynesian economics derives its name from the economist John Maynard Keynes (pronounced "cains") 1893-1946. In Keynes' treatise "General Theory of Employment, Interest and Money" published in 1936, Keynes set into motion a false economic paradigm that is still practiced today. It is difficult to pin down exactly what Keynes believed because when his theories were challenged, Keynes would dismiss the challenge saying he did not believe that anymore, and just ignore his critics.

Taking in consideration that pinning Keynes down is not an easy task, in a nutshell Keynes believed the market was driven by what he called "animal spirits" and therefore the market could not self correct when things got out of kilter. For Keynes, recessions are caused by the decline in "aggregate demand". The decline in "aggregate demand" results in unemployment, which then in turn decreases "aggregate demand" further, which deepens the recession. Keynes believed the market cannot correct immediately, therefore government needs to step in to increase "demand" by spending money. The financing of government spending would be funded by creating money and going in debt. We know that creating money is inflationary; however, in the Keynesian model inflation is necessary to combat unemployment.

Under Keynes' scenario, government spending by creating money and going into debt would solve the unemployment problem, and therefore bring the economy out of recession. In other words, when money is created out of thin air, and government spends money by going into debt, the economy is stimulated, and hence there would be no unemployment. To solve the inflation problem, under Keynes' model, the government would merely impose a surtax to take money out of circulation.

To summarize: when "animal spirits" cause the decline in "aggregate demand", this results in unemployment, which in turn causes recessions. The role of government is to increase spending (on anything) thereby increasing "demand", which will put people back to work. Government spending will be financed by creating money and going into debt. Under the Keynes model, inflation and government spending would result in full employment. Since creating money is inflationary, merely imposing a surtax would take money out of circulation, which would solve the inflation problem. Thus the fantasy goes.

Keynes' basic premises were flawed from the start. To begin, Keynes did not explain why demand for all products will decline at the same time. Instead of "animal spirits", if you have been following my newsletters, you know recessions are caused by the creation of money by the Federal Reserve, which results in bubbles. When the bubbles burst, unemployment follows, and therefore recessions.

Keynes confuses cause and effect. Rather than decline in "aggregate demand" causing recessions, it is recessions that result in a decline in "aggregate demand". Moreover, Keynes' solution of creating money to finance government spending is actually the primary trigger for recessions he is trying to cure. Keynes and his supporters also err in equating the creation of money and borrowing with production. The printing of money or borrowing money is not the same as production; just as wealth redistribution is not the same as production.

Remember the definition of "demand": "the want or desire to possess a good or service with the necessary goods, services, or financial instruments necessary to make a legal transaction for those goods or services." From the definition we can easily tell that wealth redistribution does not increase demand because there are no goods and services produced to exchange. Likewise, the printing of money is not increasing demand because money is merely a tool of exchange, not actual production.

Keynesian economics also promotes the fallacious concept of the Paradox of Thrift. We have also discussed this myth in other issues of the Note Professor Newsletters. Under this scenario anybody who does not immediately spend all of his/her earnings deprives merchants of sales, and therefore hurts the economy. When we examined this myth, we discovered that savings is the vehicle that allows an economy to expand by providing real capital for investment. We also learned that unless "buried in the back yard", all money is spent. It is just a matter of what form or when. For example, it is savings that allows a home owner to come up with a down payment for a mortgage. It is savings in a bank that gives the institution the capital to loan money for everything from cars to businesses. It is also savings that allows us to have money for a rainy day, or money for retirement. As a side note, it is the lack of savings that has compounded our economic turmoil. If more people had savings, there would be more real capital to keep the economy from shrinking.

Finally, Keynes did not address the issue of the debt created to finance government spending. When Keynes was reminded that increased government spending would create debt that in the long run could not be repaid, his answer was "in the long run we will all be dead." This concept was perfect for politicians wanting to increase government spending to buy votes. Because of its appeal to politicians, Keynesian theories were applied worldwide for almost a century.

Although Keynes is dead, WE are now living in "his long run". We are witnessing the effects of almost a century of borrowing and printing money to "stimulate" the economy. What are the effects of increased government spending for almost a century? The governments worldwide are now broke.

Keynes became the "accepted authority" in economics. In the United States, college text books taught Keynesian economics as gospel, which resulted in an entire generation being mislead that government interference was necessary to keep markets from becoming victims to "animal spirits". For decades mainstream economists touted we had a choice between inflation and unemployment. In fact, according the Keynesian thought there could not be inflation and unemployment at the same time. Why? No real answer, except "it just cannot happen".

Then came the 70s where we experienced an "inflationary recession". Remember Nixon bragging that he was a Keynesian? Nixon continued to print money to pay for the Viet Nam War and all the other government programs. The result was double digit inflation and double digit unemployment. Since this was impossibility under the Keynesian model, it was obvious that Keynes was wrong in theory and in fact.

Even though facts and logic refute Keynes, politicians from both parties still cling to his debunked theories; and with the same effects. How is quantitative easing I and II working out? How is the government "stimulus" working out? We now know not just in theory, but in reality that government cannot increase demand by spending because governments produces nothing. This is just another form of consuming without producing. Yet they continue to spend. The results are the trillions of dollars of debt without production. Sadly, no politician, Republican or Democrat, wants to face the reality they have made promises that cannot be funded. Instead, they cling to the debunked theory that politicians can spend the economy into prosperity.

Conclusion: Keynesian economics is not workable in theory or in fact. A quote from Keynes; "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist." Little did Keynes know he was describing himself.

If you have a topic you would like me to discuss or comments, please CONTACT ME.

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