When you sell your business it is very typical for you as the business owner to have to carry a portion. Also called seller financing. If this is something that you will have to do. Make sure you protect this portion of the payout. Covenants are often an overlooked component of an effective seller financing note.
A covenant is a form of ‘written agreement’ between interested partners that helps in forming the basis of an ongoing business relationship. Covenants state the broad agreement’s broad terms which exist between parties involved in the working relationship. There are some covenants which are quite vague while others are very detailed. But in all cases, there are a few points that need to be included to give a certain business arrangement function and meaning.
5 Basic Issues a Covenant Needs to Address
- A covenant must identify the parties entering into a deal. This can include names of the individuals, corporate names and DBA identities employed by either party.
- A covenant should address the main purpose of the contract.
- A covenant should also include information on the general conditions which will be applied to the relationship (e.g. identifying services that will be supplied).
- A covenant should also consider payment terms, special discounts and exceptions to delivering service based on what both parties have agreed upon.
- A covenant should also address how every party should react in emergency situations.
What are the covenants that you should include to safeguard some aspects of your business? Here are some of the most important points that a seller should cover.
- Buyer isn’t allowed to relocate the business until the note has been fully paid off.
- Buyer is not permitted to sell any asset over $5,000 of the business without obtaining permission from the original business owner.
- Buyer should maintain a standard ‘debt to equity’ ratio. This is to ensure that the business will not be overburdened with bills that it cannot afford to pay.
- The buyer should maintain only a certain number of staff members.
- The buyer salary should only be limited to a pre determined annual salary without the dividends. While this may be pretty hard to implement, it can also serve as a motivating factor for buyers to pay the loan as soon as he can.
- The buyer should provide financial and progress reports on a yearly or quarterly basis.
- The buyer is not able to sell or issue more shares and change officers of their business.
- The buyer should submit an annual business plan.
- The buyer should maintain books and records in accordance with accounting principles.
- Required general liability and insurance.
- A notice of litigation.
- Conduct of business.