Seller Note

A seller note is a financing arrangement in which the seller of a business or commercial property lends a portion of the purchase price to the buyer. Rather than receiving the full sale price at closing, the seller agrees to accept deferred payments over a defined term, secured by a promissory note. Seller notes are a standard component of business acquisition deal structures, particularly in lower middle-market transactions where buyer capital is limited.

Typical seller note terms range from 5 to 10 years, with interest rates between 4% and 8%. The note is almost always subordinated to the senior lender, meaning the seller's claim on repayment ranks below the primary acquisition loan. In many cases, the seller agrees to a standby period during which no principal or interest payments are made, allowing the business's cash flow to service the senior debt first. Standby periods of 24 months are common in SBA-backed transactions.

In SBA-financed acquisitions, seller notes play a specific structural role. The SBA requires buyers to contribute an equity injection, typically 10% to 20% of the total project cost. A seller note can satisfy a portion of that equity injection requirement, but only if the seller agrees to a full standby arrangement. Under SBA standby terms, the seller note must be on full standby for a minimum of 24 months from the date of the first disbursement of SBA loan proceeds, meaning no payments of principal or interest during that period. The SBA treats a seller note on full standby as equivalent to equity for injection calculation purposes.

The distinction between a seller note and conventional seller financing is primarily contextual. Seller financing is a broad term that applies to any transaction where the seller carries paper, including real estate deals between individuals. A seller note, in commercial acquisition parlance, specifically refers to the subordinated, structured instrument used alongside institutional lending in business purchases. The terms, subordination requirements, and standby provisions that characterize seller notes in acquisition finance are rarely present in conventional seller financing arrangements.

Seller notes are documented through a promissory note and, in most cases, a subordination agreement that governs the relationship between the seller's claim and the senior lender's claim. When an SBA loan is involved, a separate standby creditor agreement is required, executed on SBA Form 155. The senior lender and the SBA must approve the seller note terms before closing.

Seller notes are one of the most effective tools for bridging the equity gap in business acquisitions. Many qualified buyers have the operational experience and creditworthiness to secure senior financing but lack the full cash equity required to close. A seller note allows the seller to effectively finance a portion of the purchase price, reducing the amount of cash the buyer must contribute at closing. This mechanism enables transactions that would otherwise fail due to insufficient buyer liquidity, expanding the pool of viable acquirers and improving the seller's probability of completing a sale.

From a deal structure perspective, seller notes also signal alignment between buyer and seller. When a seller is willing to carry a note, it communicates confidence in the business's future performance and the buyer's ability to operate it successfully. Lenders view this favorably. A seller who demands 100% cash at closing may raise questions about the business's sustainability. Conversely, a seller willing to defer 10% to 20% of the purchase price demonstrates skin in the game during the transition period.

For the buyer, the seller note introduces a subordinated layer of debt that must be serviced after the standby period expires. This affects the debt service coverage ratio and the total leverage on the business. Buyers must model the post-standby payment schedule carefully to ensure the business can support both senior debt service and seller note payments simultaneously. Failure to account for this creates a cash flow cliff when standby expires, which is one of the most common causes of post-acquisition financial distress in seller-financed deals.

• Ignoring the post-standby cash flow impact. Buyers focus on the standby period as free money and fail to model what happens when seller note payments begin. The transition from zero seller note payments to full principal and interest can strain cash flow significantly, especially if the business has not grown as projected.
• Negotiating seller note terms in isolation from the senior loan. The senior lender and, in SBA deals, the SBA must approve the seller note terms. Negotiating a seller note with aggressive repayment terms that conflict with senior lender covenants or SBA standby requirements will force renegotiation at the worst possible time, often days before closing.
• Assuming all seller notes qualify as equity injection. Only seller notes on full standby, with no payments of principal or interest during the standby period, qualify toward SBA equity injection requirements. A seller note with interest-only payments during the standby period does not meet the standard. Buyers who build their equity injection plan around a non-qualifying seller note face a last-minute capital shortfall.
• Failing to execute the subordination agreement properly. Without a signed subordination agreement between the seller and the senior lender, the seller note creates ambiguity about creditor priority. This can delay closing, trigger lender objections, or create legal disputes if the business underperforms. In SBA transactions, the standby creditor agreement is a closing condition, not a post-closing formality.
• Underestimating the seller's leverage in note negotiations. Sellers who carry notes retain financial exposure to the business. Sophisticated sellers negotiate protective provisions including acceleration clauses, default triggers tied to business performance, and security interests in business assets. Buyers who treat the seller note as a passive instrument may find themselves subject to restrictive covenants they did not anticipate.