selling a business
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Selling a Business Using a Promissory Note: Do You Have To Charge Interest?

With many business sales, the buyer obtains a loan from a commercial lender. Lenders, typically banks, are experts at documenting their loan to the buyer to make sure they get their money back. Lenders have banks (no pun intended) of form documents to help them gather and record the details of the transaction and provide for contingencies.  In deals where a commercial lender is not involved, the parties often want to forgo the formalities a commercial lender would require and carry out the sale using documents they assume are good enough. Less formality can be costly to a seller if the deal involves the buyer making a down payment at closing together with a promise to pay the balance over time.

If as a seller you agree to accept payments over time, you are a lender and you have made a loan. If you have not put agreements in place similar to the documentation a commercial lender would use, you will fail to address critical terms. A less formal agreement might fail to clearly define when payments are to be made, when the final payment is due, how interest will be accrue, how payments will be applied, or what happens when the other person doesn’t pay as promised. Trying to interpret what was meant when terms are inconsistent or missing, usually costs many times more than having a proper agreement and promissory note prepared in the first place.

There are a couple of items that come up frequently, and should not be overlooked: Interest and security (collateral). This article will address the issue of interest, and security will be discussed in a follow up.

With Few Exceptions, You Need to Charge Interest

Many transactions are between business partners or acquaintances, people who consider each other friends. The buyer doesn’t want to have to pay interest, and the seller feels funny asking for it, so they agree, no interest. Unfortunately, the IRS may “impute” interest received to the seller, even if the parties agreed to zero interest or a rate below the IRS’ published rates. As the saying goes, there’s no such thing as a free lunch. Here is how the IRS will treat various situations.

Of course, there are nuances, and exceptions to the exceptions, but it is safe to say that no one should enter into deal with a payment plan that charges no interest or interest at too low of a rate, without checking with their accountant on the IRS rules and the current applicable federal rate.  And while it may cost a little more now, working with an attorney who can spot these issues and draft the proper agreements for you will save surprises, and money, down the road. Whether you are buying or selling, the attorneys at Bartelt Grob, S.C. can help you navigate the process.