The Seller Is Financing My Acquisition — What Should the Seller Note Say?
Seller financing — also called a seller note or seller carryback — is a common structure in small and mid-sized business acquisitions. Rather than the buyer paying the full purchase price at closing, the seller agrees to accept a portion of the price over time, evidenced by a promissory note from the buyer. This arrangement benefits buyers who cannot finance the full purchase price through conventional lending and sellers who want to facilitate a sale they might not otherwise be able to close.
Why Seller Notes Are Common in Small Business Deals
Many small business acquisitions involve businesses that generate strong cash flow but have limited hard assets. Conventional lenders — banks, SBA lenders — may be willing to finance only a portion of the purchase price because the collateral base is thin. The seller note fills the gap between what a conventional lender will provide and the full purchase price. It is also sometimes structured as an alignment mechanism — the seller has a financial incentive to support a successful transition because their note payments depend on the business continuing to perform.
What the Promissory Note Should Address
The seller note is a legally binding debt instrument. Its terms determine the buyer’s obligations and the seller’s remedies if the buyer defaults. Key terms that practitioners focus on include the principal amount, the interest rate, the repayment schedule — whether payments are monthly, quarterly, or balloon at a certain date — and the maturity date.
Equally important are the default provisions. What events constitute a default? What notice, if any, must the seller provide before exercising remedies? What remedies does the seller have — acceleration of the full balance, a right to take back the business, or simply a breach of contract claim? The answers to these questions are negotiated, and the specific language matters considerably.
Subordination and Intercreditor Issues
If the buyer is also obtaining bank financing — including an SBA loan — the bank will almost certainly require that the seller note be subordinated to the bank’s debt. This means the seller cannot receive payments on the note while the buyer is in default to the bank, and in some cases the seller may be required to subordinate for the entire term of the bank loan. The specific terms of any subordination agreement are negotiated between the seller, the buyer, and the bank, and they significantly affect the seller’s risk profile on the note.
Security for the Seller Note
Sellers who carry back a note often seek security for the obligation — a pledge of the buyer’s equity in the acquired business, a security interest in the business’s assets, or a personal guarantee from the buyer. The availability of security and its priority relative to bank debt are negotiated issues. A seller note that is unsecured and subordinated to bank debt carries significant risk if the business underperforms after closing.
Offset Rights
Buyers sometimes seek the right to offset indemnification claims against the seller note — meaning that if the buyer has a valid claim for breach of representations and warranties in the purchase agreement, the buyer can reduce its note payments by the amount of the claim. Sellers typically resist broad offset rights. The scope of any offset right and the process for asserting it are important negotiating points that should be addressed explicitly in the note or the purchase agreement.
Business owners on either side of a seller-financed acquisition should work with a business attorney to review the promissory note and related documents before closing. For more, see our pages on buying a business and selling a business.
Business owners on either side of a seller-financed acquisition are welcome to schedule a consultation with Russo Law LLC to review the promissory note and related documents before closing.
Disclaimer
The legal and business issues discussed in this post vary depending on the specific facts and circumstances of each situation. The legal and business issues discussed in this post vary depending on the specific facts and circumstances of each situation. This corporate lawyer blog post is for informational purposes only and does not constitute legal advice. It is not an offer for Russo Law LLC to represent any party, nor does it create an attorney-client relationship. No action or inaction should be taken based on the information provided without seeking professional legal counsel. This post is intended for businesses in New York and New Jersey. It may not reflect laws in other jurisdictions.
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