Key takeaways
- Seller financing almost always signals that the seller and buyer disagree on risk.
- Understand the subordination terms and default provisions before agreeing to take a note.
- A promissory note from a PE-backed buyer has different risk than one from an individual.
- Seller financing is priced as higher yield to compensate for junior position in the capital structure.
- Negotiate the note terms in the LOI, not after the purchase agreement is drafted.
5–15%
Seller note as % of purchase price (typical)
6–8%
Interest rate range on middle market seller notes
3–5 years
Standard note amortization period
Subordinated
How seller notes rank vs. senior bank debt
A seller note, a promissory note where the buyer pays a portion of the purchase price to the seller over time, is a common structural component in lower and middle market transactions. Buyers propose them to reduce the day-one cash requirement; sellers accept them to close valuation gaps or signal confidence in the business. Understanding the risk profile and negotiating protections is more important than the face value of the note.
Seller notes appear in approximately 35–45% of lower-middle-market transactions under $25M, most commonly as bridge instruments between the seller's valuation and the buyer's ability to finance at close.
In SBA-financed transactions, seller notes are often structurally required, SBA lenders may mandate that the seller take back 10% of the purchase price as a subordinated note as a condition of loan approval.
For sellers, the note represents real credit risk: if the business underperforms post-close, the buyer's ability to service the note may be impaired.
When seller notes make sense, and when they do not
Seller notes make sense in three contexts: when they bridge a genuine valuation gap that cannot be closed through earnout or rollover equity; when the buyer's credit profile is strong and the business's performance under new ownership is predictable; and in SBA-financed transactions where the lender structurally requires seller participation.
They make less sense when: the buyer is thinly capitalized and the note represents meaningful credit risk; when the note is proposed as a substitute for upfront consideration the buyer should be able to finance; or when the seller does not have visibility into how the business will be operated post-close.
A seller note is not the same as deferred consideration. A seller note is debt, it requires the business to generate sufficient cash flow to service both the senior bank debt and the seller note, typically in a subordinated position. If the business underperforms post-close, the senior lender gets paid first; the seller note may defer or default. Sellers who treat the note as equivalent to cash at closing are underpricing the credit risk they are retaining.
What to negotiate
A founder of a $14M specialty distribution company received a PE-backed acquisition offer that included a $1.4M seller note at 6.5% over 4 years, subordinated to $6M of senior bank debt. He negotiated three specific protections: a personal guarantee from the two PE principals individually, a financial covenant requiring the business to maintain 1.2x DSCR or the note accelerated, and an acceleration clause requiring full payment if the business was sold or refinanced within the hold period. Twenty-six months post-close, the business hit a growth plateau and the PE firm initiated an add-on acquisition that triggered the acceleration clause. The full remaining note balance of $840K became immediately due. Because the clause was in the note, the seller received $840K at a point when a buyer without protections would have continued to receive quarterly payments for another 22 months with credit risk from a business carrying new acquisition debt.
Seller Note Negotiation Priorities
1. Interest rate
Benchmark to current SBA lending rates (currently 7–9%); negotiate minimum 6–7% for a 3–5 year term
2. Amortization period
Shorter is better for seller; 3 years preferred over 5 for risk management
3. Personal guarantee
If the buyer is an individual or small holding company, require a personal guarantee from the principals
4. Security interest
Negotiate a lien on business assets junior to senior lender; this provides a recovery path if the business defaults
5. Financial covenant
Require the buyer to maintain a minimum DSCR (debt service coverage ratio), breach triggers an event of default on the note
6. Prepayment option
Include the right for the buyer to prepay without penalty; many buyers will exercise this if the business performs well, shortening the seller's exposure
7. Acceleration clause
The full note balance becomes due immediately if the buyer sells the business, takes on additional senior debt, or misses a payment
?>What interest rate should a seller note carry?|Middle market seller notes in the current environment typically carry 6–8% annual interest on a 3–5 year amortization schedule. The appropriate rate depends on the buyer's credit profile, the note's position in the capital structure (subordinated vs. mezzanine), and the overall transaction structure. Notes in SBA transactions are often capped by the SBA program at specific rates and standstill requirements.||What happens if the buyer cannot pay the seller note?|If the business underperforms and cash flow is insufficient to service debt, the senior lender (bank) gets paid first. The seller note, in a subordinated position, may be deferred or may default. Sellers can protect themselves through: personal guarantees from the buyer's principals, security interests in business assets, financial covenants that trigger early default, and acceleration clauses that require immediate payment if the business is sold.||When is a seller note required?|Seller notes are typically required in SBA 7(a) financed transactions, the SBA lender often mandates that the seller take back 10% of the purchase price in a subordinated note that is on standstill for the first 24 months. Outside of SBA financing, seller notes are negotiated components, not requirements. Their presence or absence depends on the buyer's financing capacity and the seller's leverage in the process.
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Discuss Deal Structure and Seller Note Terms
Most useful during LOI negotiation or when evaluating a proposed deal structure.
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