Sellers!  Do you know how to protect yourself from a buyer’s inability to pay fully?  Buyers! Do you know how to protect yourself from an unexpected decrease in revenue?

Most buyers do not have enough available cash to pay for a business upfront, which necessitates the formation of a payment plan.  What’s the seller’s guarantee, though, that the buyer will fulfill the agreement and pay all principal and interest by the agreed upon date?  Similarly, what’s the buyer’s guarantee that the business will not tarnish once he acquires it, causing him to struggle to pay the seller?  One option is to execute a promissory note.

Using a Promissory Note allows relief for both parties

Click here for a sample Promissory Note, as well as other sample legal documents.

A promissory note is a legally binding document that sets out the terms for a promise for one party to pay another party a specified sum by a specified date.

In a promissory note, the terms of the payment plan are included and agreed to by both parties.  To address concerns on the buyer’s side, a promissory note can be arranged such that if annual sales (the gross receipts of the business) under the buyer decrease compared to the previous year’s sales (under the seller), the amount to be paid by the buyer is also decreased.  For instance, 2012 sales amount to $300,000 and then 2013 sales, which occur under the new owner (the buyer), shrink to $250,000.  Since this $50,000 decrease constitutes a 17% drop in sales, the regular payments made by the buyer to the seller will be reduced by 17%.

What’s the incentive for the seller?

Depending on the price of a business, a buyer may not provide a lump sum payment to a seller; either they want to see how the business performs under their ownership or they simply do not have the capital.  Taking back a promissory note gives the seller the opportunity to market to a broader group of buyers who may otherwise be qualified to operate the business but yet are unwilling or unable to pay the entire cost at once.

Additionally, if the buyer defaults on the payment terms, the seller has recourse to help cover the loss, usually in the form of tangible assets held by the business.  In this case, the seller has a right to the business’s assets if the buyer fails to pay.  The terms of the note can call for additional penalties—for example, late penalties, a higher interest rate, or acceleration—if the buyer defaults.

As you can see, there are benefits to both a buyer and a seller to establishing a promissory note. If you are soon to be engaged in a purchase or sale and would like assistance in creating forms such as this one, contact Business Legal Services Inc!  We can be reached at (703) 486-0700 or