PROMISSORY NOTE requirements for a BUSINESS ACQUISITION
Business Purchase - Letter of Intent - Due Diligence - Negotiations - Asset vs Share - Purchase Agreement - Closing
Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
A promissory note in a business acquisition serves as the formal legal instrument evidencing a debt owed by the buyer to the seller for a portion of the purchase price. It serves as a sophisticated deferred consideration vehicle that bridges the valuation gap between what a buyer can pay upfront and the total price the seller demands. Its most fundamental requirement is the clear definition of the principal amount (the debt), the obligor (the buyer entity), and the holder (the seller), establishing an unconditional promise to pay that survives the closing of the deal. This instrument effectively turns the seller into a lender, requiring them to assess the creditworthiness of the buyer and the future cash flows of the business they are selling.
The financial structure of the promissory note is a critical aspect, dictating the repayment schedule and interest rate. These terms must be meticulously calibrated to the acquired company's projected cash flow; if the payments are too aggressive, they can choke the business's liquidity, increasing the risk of default. Critical components here include the amortization schedule (interest-only periods vs. fully amortizing payments), the maturity date (when the full balance is due), and whether there is a balloon payment at the end. The interest rate must be distinct from the purchase price to satisfy tax authorities (avoiding imputed interest rules) and is often negotiated based on the risk profile of the buyer, typically sitting between senior bank debt rates and mezzanine financing rates.
Risk mitigation mechanisms, specifically security and subordination, is a further aspect that is critical to a promissory note. A robust promissory note rarely stands alone; it is usually secured by a General Security Agreement granting the seller a lien on the business assets (inventory, receivables, equipment) or a Share Pledge Agreement securing the stock of the company. However, this security is almost always subordinated to a senior lender (like a bank or financial institution). The Subordination Agreement is a critical requirement in leveraged buyouts, dictating that the senior lender gets paid first in the event of a liquidation. This hierarchy significantly alters the seller's risk, making the specific terms of subordination (e.g., "standstill" periods where the seller cannot enforce remedies) a hotly contested negotiation point.
Finally, the promissory note must contain comprehensive default provisions and protective covenants to govern "what if" scenarios. This includes defining Events of Default not just as missed payments, but also as breaches of financial covenants (like maintaining a certain debt-service coverage ratio) or the insolvency of the buyer. Crucially, in business acquisitions, the note often features a Right of Set-Off clause. This allows the buyer to withhold future payments due under the note to cover indemnification claims (such as breaches of representations or warranties discovered post-closing). This transforms the note from a simple debt instrument into a strategic tool for the buyer, serving as a de facto escrow account to ensure the business is delivered as promised.
For knowledgeable and experienced legal representation when purchasing or selling a business, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.
|
Purpose of a Share Purchase Agreement. A Share Purchase Agreement is a legally binding contract that outlines the terms and conditions for the sale and transfer of shares in a corporation from its current shareholders (the Vendor) to the Purchaser. The functional purpose of a Share Purchase Agreement includes . . . Read more. |
|
10 Key Aspects of an Asset Purchase Agreement. An Asset Purchase Agreement is the contractual document between the purchaser and the vendor that sets out the legal terms and conditions of the transaction of purchase and sale of specific assets of a corporation or business. The following represents 10 key aspects of consideration . . . Read more. |
