Understanding the Seller Notes Terminology in Veterinary Financing Deals
In the last article, Dr. John Bryk explained buyer loan pre–approval, and this month I will explain how Veterinary Financing utilizes Seller Notes. Before I begin, I want to go over the basic terms used in Veterinary Financing.
Interest Rate The amount a lender charges for the use of assets expressed as a percentage of the principal
Variable Interest Rate Sometimes called an “adjustable“ or a “floating“ rate) is an interest rate on a loan or security that fluctuates over time because it is based on an underlying benchmark interest rate or index that changes periodically.
Fixed Interest Rate It is a constant rate charged on a liability, such as a loan or a mortgage period.
Closing Costs Sometimes called settlement costs, are the fees you pay when obtaining your loan.
SBA Loan It usually has a variable interest rate, is guaranteed by the Federal Government (U.S. Small Business Administration), and the borrower has to provide SBA insurance for the loan. The equity requirements and credit rating requirements are lower, but the interest rates and closing costs are higher.
Conventional Loan The Interest rate is usually fixed, the bank supports the loan, it has higher equity requirements and a higher credit rating from the borrowers
Equity The ownership of assets that may have debts or other liabilities attached to them. Equity is measured for accounting purposes by subtracting liabilities from the value of an asset.
Amortization The length of time it takes to fully pay off an amount owed by paying principal and interest incremental payments.
Term The length of time of the mortgage agreement that an agreed interest rate is in effect.
Balloon A type of loan that does not fully amortize over its term. Since it doesn’t mature, a balloon payment is required at the end of the time to repay the remaining principal balance of the loan
Seller Note An alternative form of business capital that is flexible but carries certain risks. The seller agrees to accept a portion of the purchase price in a series of deferred payments. The Seller note occurs when the buyer‘s bank loan does not cover the entire purchase price.
CDA A legal contract that protects proprietary information and binds the parties to hold information in confidence.
Letter of Intent A document declaring the preliminary commitment of one party to do business with another. The letter outlines the chief terms of a prospective deal.
Nearly every Veterinarian has bought or sold a home. When purchasing a home, the bank requires a down payment against the note. When working with veterinary specific lenders, buyers are not required to make a down payment if the seller will agree to hold a portion of the loan to make up for the down payment that may be requested by the lender. This portion of the note is called the Seller Note. The bank uses the seller note to make sure the seller has an incentive to help the new owner succeed.
The seller note is usually 20% of the real estate value if the owner sells both the practice and real estate. The seller note is generally 20% of the practice value when the seller only sells the practice. These values can vary depending on the type of loan. SBA lenders typically require a 10% equity injection of the practice value and Real Estate cost combined, of which 5% can be a seller note, while conventional lenders usually require 20% of the real estate value.
Regardless of whether the loan is on the practice or the real estate, the seller must sign a subordination agreement to the bank, demonstrating the bank‘s first mortgage privilege. In the event of foreclosure, the bank is first in line to recover losses. The seller will receive no further payments. Veterinary loans are statically very secure loans, and less than 1% fail.
The seller note is generally required to have the same interest rate and amortization schedule as the bank‘s financing. In some instances, the bank will allow a five-year balloon and an increase in interest rate after the initial 24-month period. The seller will receive principal and interest payments generally beginning the first month after closing. After the initial five year period, the bank requires the buyer to refinance the remaining principal balance owed to the seller, thus ending the seller‘s risk.
Example – Practice Price $1M, Real Estate Price $500K
Conventional Loan – Full Practice Price, 80% of Real Estate
Seller receives $1.4M at closing and holds a seller note for at least two years for $100K.
SBA Loan – 90% of Practice and Real Estate combined
Seller receives $1.35M at closing and may hold a seller note for $75,000 and the buyer has to inject $75,000
Dr. Bill Crank
Mid-Atlantic and Northeast Territory