Seller financing when you buy a business

When you buy a business, the seller can be one of your best sources of capital. A seller note lets the buyer pay part of the price over time instead of at closing. It narrows the gap between what a bank will lend and what the deal costs. It also tells every other party at the table that the seller believes in the business they are handing over.

What a seller note is

A seller note is a loan from the seller to the buyer, used to fund part of the purchase price. The buyer signs a promissory note and makes payments to the seller after closing. The note is usually subordinate to the senior lender, which means the bank gets paid first if something goes wrong.

In a typical acquisition, the capital stack has three layers:

• Senior debt from a bank, an SBA lender, or another commercial lender
• A seller note that sits behind the senior debt
• Equity from the buyer, and sometimes from outside partners

The seller note fills the middle. Without it, the buyer would need more equity or a more expensive layer of junior capital.

Why sellers agree to carry paper

Some sellers resist at first. They want to be paid in full and walk away. But a note can serve the seller well too.

• It can support a higher price than an all cash buyer would pay.
• It can widen the pool of qualified buyers.
• It may allow the seller to receive proceeds over several years, which can matter for tax planning. That question belongs with the seller's CPA.
• It keeps the seller engaged in a smooth transition, since part of the price depends on the business continuing to perform.

Senior lenders often view a seller note favorably for the same reason. A seller who carries paper is signaling confidence in the cash flow.

Terms that matter

Every seller note is negotiated. The points below drive most of the value for both sides.

Size and rate

The note amount, the interest rate, and the amortization schedule set the buyer's payment. A longer amortization lowers the payment. A balloon at the end can keep payments light early but creates a refinance or payoff event later.

Standstill and subordination

The senior lender will almost always require a subordination agreement. It may limit when the seller can be paid, block payments if the borrower breaks a loan covenant, and restrict the seller's remedies. SBA loans carry their own rules on seller notes, including when payments can begin if the note counts toward the buyer's equity injection. Read these terms carefully before you assume a payment schedule.

Security and guarantees

Sellers often ask for a lien on business assets behind the bank, or a personal guarantee from the buyer. Each request shifts risk. Each should be weighed against what the buyer receives in price and terms.

Offsets and earnouts

Some notes allow the buyer to reduce payments if representations made in the purchase agreement prove untrue. Others tie part of the payment to future revenue or earnings. These features protect the buyer but need precise drafting to avoid disputes.

How a seller note fits the overall plan

A seller note is one piece of the sources and uses, not the whole answer. Before you propose one, know three things:

• How much senior debt the business can support based on its cash flow
• How much equity you can commit, and whether the lender will count any part of the note as equity
• Whether the combined payments on all debt leave enough room to run and grow the business

If the total debt service crowds out working capital, the structure is wrong even if it closes. A good plan leaves cushion for a slow quarter, a key hire, or an equipment repair.

Bringing it together

Seller financing works best when it is planned alongside the senior loan, not added at the last minute to close a gap. The senior lender, the seller, and the buyer each need to see terms that fit together. If you are evaluating an acquisition, our capital stack tool can help you see how the layers combine. When you are ready to talk through a specific deal, reach out to us.

Thomas Capital Holdings is not a registered investment adviser and does not provide investment advice or recommend securities. Consult your own advisors about your situation.