A seller note is a loan the seller extends to the buyer for part of the purchase price, documented as a promissory note and repaid out of the cash flow of the business after closing. In lower-middle-market deals a note typically covers 10 to 30 percent of the price, runs three to seven years, and carries a fixed rate in the mid to high single digits. Nearly every seller note sits behind the bank: senior lenders require subordination, and SBA lenders count a note toward the buyer's required equity injection only if it sits on full standby, with no payments at all, for the life of the SBA loan.
What a Seller Note Is and Why Deals Use One
Seller financing, sometimes called a vendor take-back, means the seller does not receive the full price in cash at closing. Part of the consideration arrives instead as a promissory note: a signed promise from the buyer to repay a stated amount, at a stated interest rate, on a stated schedule. Its job is to bridge the gap between the purchase price and the amount of the business a lender is willing to finance.
The gap exists because lenders size loans off collateral and cash flow, not off the negotiated price. Suppose a distribution business earning $2 million of EBITDA (earnings before interest, taxes, depreciation, and amortization) sells for $10 million. A bank may lend $6 million against that cash flow. If the buyer brings $2.5 million of equity, the remaining $1.5 million, or 15 percent of the price, is a natural seller note. Notes also bridge disagreements about value, and they carry a signal: a seller willing to lend against the business is telling the buyer and the bank that the earnings are real.
How Large Is a Typical Seller Note?
Two reference points frame the market. Morgan & Westfield's seller financing guide puts middle-market seller notes at 10 to 30 percent of the purchase price and observes that few small businesses sell for all cash. Axial, which runs a lower-middle-market deal network, reviewed 100 letters of intent submitted through its platform and found median seller notes between roughly 12 and 18 percent of total enterprise value (TEV, the value of the whole business including its debt), varying by buyer type.
| Buyer type | Median seller note (% of TEV) |
|---|---|
| Family offices | 18.2% |
| Independent sponsors | 16.7% |
| Search funds | 16.7% |
| Private equity firms | 13.6% |
| Holding companies | 12.9% |
| Individual investors | 11.9% |
| Corporations | 11.8% |
The same review, admittedly a small sample, found that smaller transactions tend to carry proportionally larger notes, with a few outliers above 40 percent of TEV. The pattern is intuitive: the smaller the deal, the thinner the available bank financing, and the more the seller is asked to carry.
Interest Rates, Term, and Repayment Structure
Most seller notes carry a fixed rate. Morgan & Westfield reports 6 to 8 percent as the prevailing range over roughly the past decade, priced off deal risk rather than off benchmark rates. Because a subordinated note is riskier than the bank's senior position, its rate should sit above the senior loan's rate, and a note on long standby deserves a further premium.
Terms usually run three to seven years, with five years common. Repayment takes one of three shapes: fully amortizing (equal payments of principal and interest), interest-only for a year or two and then amortizing, or amortizing with a balloon payment (a large final installment) at maturity. Whatever the shape, the payment must fit comfortably inside the free cash flow left after senior debt service. A note the business cannot service is a dispute waiting to happen, not consideration.
Two tax mechanics matter. First, if the stated rate is below the applicable federal rate (the AFR, a minimum rate the IRS publishes monthly), the IRS treats part of the principal as unstated interest, so a note should always carry at least the AFR. Second, a seller note usually creates an installment sale: unless the seller elects out, gain is reported on Form 6252 as payments are received rather than all at closing, and the note's interest is taxed as ordinary income. This discussion is educational, not legal or tax advice; have qualified counsel and a tax advisor review any note before signing.
Standby and Subordination to Senior Lenders
Whenever a bank funds most of the price, it will require the seller to sign a subordination agreement placing the note behind the senior loan. Subordination is not one concept but three, and sellers should understand each before agreeing.
- Payment subordination. The senior lender can block payments on the note after a trigger event, typically a senior default. A payment blockage can start automatically or on written notice, and depending on the drafting it can last a fixed number of days or run until the senior loan is repaid in full. Push for a capped blockage period and for missed payments to accrue and catch up once the default is cured.
- Lien subordination. Any security interest the seller holds ranks behind the bank's lien on the same collateral, so in a liquidation the bank is paid first.
- Remedy subordination, or standstill. After a default on the note, the seller must wait before suing, accelerating, or foreclosing. Standstill periods commonly run at least 180 days, and aggressive drafts extend them until the senior lender has been paid in full.
The practical takeaway: a subordinated note's remedies section is weaker than it looks. Negotiate notice rights, a right to cure the buyer's senior default, and regular financial reporting so a problem surfaces early, while there is still something to protect.
SBA Standby Requirements Under SOP 50 10 8
Acquisitions financed with SBA 7(a) loans follow stricter and very specific rules. Under SOP 50 10 8, the SBA's lending procedure effective June 1, 2025, a complete change of ownership requires a minimum equity injection of 10 percent of total project costs. A seller note may count toward that injection only if two conditions hold: the note is on full standby, meaning no principal or interest payments for the entire life of the SBA loan (often 10 years), and the note supplies no more than half of the required injection.
Concretely: on a $3,000,000 total project cost, the injection is $300,000. A full-standby seller note can cover at most $150,000 of it; the buyer must put in at least $150,000 in cash. A seller can still hold a larger note above the injection amount, but that piece is ordinary deal financing the lender must underwrite and approve, not equity credit. Standby terms are documented on SBA Form 155, the Standby Creditor's Agreement, or a lender's equivalent form. Under Form 155 the seller subordinates any lien rights to the SBA lender and agrees to take no action against the borrower or the collateral without the lender's consent. Sellers weighing a full-standby note should value it accordingly: money that may not move for a decade is not the same as cash.
Security and Default Remedies
Seller notes are usually unsecured or secured on a junior basis. Where security is granted, the standard package is a security interest in the business assets perfected by a UCC-1 financing statement (the public filing that establishes lien priority), sitting behind the senior lender's first lien. Some deals add a pledge of the buyer's equity in the acquired company or a personal guarantee from the buyer's principals, though guarantees are negotiated, not assumed. Buyers often push the other way, seeking a right of offset that lets them reduce note payments by indemnity claims under the purchase agreement; sellers should cap any offset and confine it to finally resolved claims.
Where there is no bank in front, the note can carry real teeth: late charges, default interest, acceleration of the full balance, financial reporting covenants, and ultimately foreclosure on the assets. Behind a senior lender the same clauses exist on paper but operate through the blockage and standstill limits described above, and under an SBA standby agreement they are effectively frozen until the SBA loan is gone. Behind senior debt, the note's real protection is the quality of the business and the size of the buyer's cash equity cushion, not the remedies section.
When a Note Strengthens a Deal, and When It Weakens One
Signs the Note Strengthens the Deal
- It fills a genuine financing gap of roughly 10 to 20 percent of the price, alongside real buyer cash equity and sensible senior debt.
- It carries a market rate, a defined amortization schedule, and payments the projected cash flow covers comfortably.
- It widens the buyer pool for smaller companies that banks underserve, which supports competitive tension and price.
- It signals confidence to the lender and buyer, which can improve senior terms.
Signs the Note Weakens the Deal
- It substitutes for buyer equity rather than supplementing it. A buyer with little cash at risk can walk away from trouble; the seller cannot.
- It papers over a valuation gap. If the headline price only works because a third of it is a soft note, the real price is lower than it looks.
- It sits on deep or full standby but is negotiated as if it were cash. Discount long-standby paper when comparing offers.
- The subordination terms have no blockage cap, no notice rights, and no reporting covenants, leaving the seller blind until the note is already impaired.
Owners comparing offers should reduce every structure to risk-adjusted, after-tax proceeds; sell-side platforms such as Bankerly.ai model note size, standby terms, and installment timing alongside all-cash alternatives for exactly this comparison. A well-built seller note gets a good deal closed. A badly built one quietly converts sale proceeds back into business risk the owner thought they had sold.
Sources
- Axial: Understanding Seller Notes in M&A: Insights from 100 LOIs
- Morgan & Westfield: M&A Seller Financing: A Complete Guide
- Whiteford, Taylor & Preston: Client Alert: SBA Issues SOP 50 10 8: Key Changes Impacting SBA 7(a) Lending
- U.S. Small Business Administration: SBA Form 155, Standby Creditor's Agreement
- Hackett Feinberg: Why Do We Care About Payment Blockage, Standstills and Other Remedies in Subordination & Intercreditor Agreements?
- IRS: Topic No. 705, Installment Sales
Frequently asked questions
- How much seller financing is typical when selling a business?
- In lower-middle-market deals, seller notes most often cover 10 to 30 percent of the purchase price. An Axial review of 100 letters of intent found median notes of roughly 12 to 18 percent of enterprise value depending on buyer type, with smaller deals skewing higher and a few outliers above 40 percent. All-cash sales of small businesses are the exception, not the rule.
- What is a typical interest rate on a seller note?
- Most seller notes carry a fixed rate, and 6 to 8 percent has been the common range over roughly the past decade. Because the note usually sits behind a senior lender, its rate should exceed the bank's rate, and full-standby notes deserve a further premium. The rate must at least equal the IRS applicable federal rate or part of the principal is recharacterized as imputed interest.
- Does a seller note count as the equity injection on an SBA 7(a) loan?
- Only partly. Under SBA SOP 50 10 8, effective June 1, 2025, a complete change of ownership requires a 10 percent equity injection, and a seller note counts only if it is on full standby, with no principal or interest payments, for the entire life of the SBA loan. Even then it can supply at most half of the injection; the buyer must contribute the rest in cash.
- What happens if the buyer defaults on a seller note?
- It depends on subordination. A first-position secured note lets the seller charge default interest, accelerate the balance, and foreclose on collateral. Behind a senior lender, payment blockage and standstill provisions, often 180 days or longer, delay those remedies, and under an SBA standby agreement the seller may take no action without the lender's consent. Negotiate notice, cure, and reporting rights up front.
- Is offering seller financing a good idea when selling my business?
- Often yes, in moderation. A note of 10 to 20 percent of the price widens the buyer pool, signals confidence, and frequently supports a stronger price than demanding all cash. It weakens a deal when it substitutes for genuine buyer equity or masks a valuation gap. Weigh each offer on risk-adjusted, after-tax proceeds with help from qualified advisors.
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