What is a seller note and how does it work?

A seller note is a loan from you to the buyer, documented in a promissory note the buyer signs at closing for part of the purchase price. The buyer pays the rest in cash at closing, funded by their own money plus a bank loan when one is used. You then collect the note over the schedule you negotiated.

The note states five things: principal, interest rate, payment schedule, maturity, and what happens on default. You and the buyer negotiate every one of them, and the buyer's lender can restrict them. Three terms carry the most weight for you:

• Security. A lien on the business assets, which sits behind the bank's lien if the bank requires first position.
• Guarantee. A personal guarantee from the buyer, so you can collect from the person and not only from the company.
• Acceleration. A clause that makes the full balance due if the buyer misses payments or sells the company.

For the full range of structures, see the seller financing guide. Before you agree to any amount, get the rate, payment schedule, and default remedies written into the LOI, because the lender and the attorneys will build the note from that letter.

In an SBA deal, a seller note counts toward the buyer's equity only if it is on full standby, which means you receive no principal or interest until the SBA loan is repaid. The rule applies to a complete change of ownership: the buyer must put in 10% of total project cost, and up to half of that can be your standby note. Five percent buyer cash plus a 5% standby note is common. The standby is documented on SBA Form 155.

Here is the math on a $1,000,000 total project cost, assuming the purchase price is the whole project:

• Required injection: 10% of $1,000,000, or $100,000.
• Buyer cash: $50,000. Your standby note: $50,000.
• SBA loan: the remaining $900,000.
• You receive $950,000 at closing and hold a $50,000 note.

That $50,000 can wait as long as the SBA loan runs, and the business-acquisition portion of a 7(a) loan amortizes over a maximum of 10 years. Interest may accrue and be added to the standby balance, to be amortized after the SBA loan is paid in full. The buyer cannot refinance a standby note out early. The 36-month seasoning rule applies to notes that are paid as agreed, not to standby notes.

A note that is not on full standby works differently. Its payments count in the lender's debt service, and the SBA requires at least 1.25x coverage on historical results (the last fiscal year or a two-year average) for an Initial Acquisition, Owner Buyout or ESOP transaction; projections cannot be relied on to meet it. The floor is 1.15x for a Business Expansion. An interest-only note is amortized over no more than 10 years for that test. Total acquisition debt, meaning the SBA loan plus seller debt not on full standby, also cannot exceed the lender's independent valuation, which is required when the purchase price is above $350,000. If you want payments in the first years, ask the buyer's lender to run the coverage test with your note payments included before you sign the LOI.

Accept a seller note when the price or the buyer pool justifies waiting, and only with protections written into the purchase agreement. A buyer who can fund the full 10% injection from cash and other unlimited sources does not need your note. A buyer who needs it is asking you to carry risk, so ask for something in return, such as a higher price or a higher rate.

Ask for these in the agreement:

• A lien on business assets and the buyer's personal guarantee.
• A defined default, a short cure period, and acceleration of the balance.
• Limits on the buyer's right to offset indemnity claims against note payments.
• Reporting rights, so you see financial statements while you are a creditor.

Be clear about what a standby note gives up. While the SBA loan is outstanding, you cannot demand payment, and the lender controls your remedies. That makes the buyer's operating ability and the price you accept at closing more important than the note's default language.

Taxes also move with the structure. Gain on a note is generally reported as payments arrive, but depreciation recapture is generally taxed in the year of sale even when you are paid over time. Read what depreciation recapture is in a business sale first, then ask your CPA to model the year-of-sale tax bill against the cash you receive at closing so you know whether the cash portion covers it.