Seller notes are one of the most misunderstood instruments in acquisition financing. Buyers think they understand them. Sellers think they understand them. Then everyone gets to the closing table and discovers that the structure they agreed to in the LOI doesn't work for the lender.
Here's the framework you actually need.
What Is a Seller Note?
A seller note is a loan from the seller to the buyer, used to bridge the gap between the buyer's equity injection, the primary lender's loan, and the purchase price.
Example:
- Purchase price: $2,000,000
- SBA 7(a) loan: $1,650,000
- Buyer equity injection: $250,000
- Seller note: $100,000
Full Standby vs. Partial Standby
This is where most deals go sideways.
Full standby means the seller cannot receive any principal or interest payments on their note for the entire term of the SBA loan — typically 10 years. The seller gets their money at the end, not along the way.
Partial standby means the seller receives interest-only payments during a deferral period (usually 24 months), then both principal and interest after that.
Why this matters for your deal:
The SBA requires a minimum equity injection of 10% of the total project cost. A seller note on full standby counts toward the 10% equity injection requirement. A seller note on partial standby does not.
This is a critical distinction. If your seller note is on partial standby, you need to fund the entire 10% from your own cash. If it's on full standby, the seller note can satisfy up to 5% of that requirement — meaning you only need 5% cash equity.
When Sellers Will (and Won't) Accept Full Standby
Full standby is a hard sell to most sellers. They're being asked to loan you money and receive nothing for 10 years. It works when:
- The seller is highly motivated to close and the buyer can't come up with more cash
- The seller trusts the buyer's ability to operate the business
- The seller note represents a small percentage of the total purchase price
- The interest rate on the note compensates for the deferral risk
Most sellers will push for partial standby. When they do, the buyer needs to fund the full 10% equity injection in cash — which changes the deal math significantly.
Structuring the Rate
SBA guidelines cap seller note interest rates on full-standby notes. Check current SBA SOP for the current cap — it's typically tied to the prime rate.
For partial standby notes, the rate is negotiable. Sellers typically want prime + 2–3%. Buyers want as low as possible. The practical range is 6–9% in the current rate environment.
The Tax Angle
Seller notes create installment sale treatment for the seller (assuming they elect it). This spreads their gain recognition over the term of the note rather than recognizing it all in the year of sale. For sellers with large capital gains, this is a meaningful benefit that can make them more willing to carry a note.
Use this as a negotiating point: the seller note may be worth more to them after-tax than an equivalent amount of cash at close.
What to Put in the LOI
Be explicit about standby terms in the LOI. Vague language like "seller will carry a $200K note" creates problems. Say:
"Seller will carry a $200,000 subordinated promissory note at 7% interest, on full standby for the term of the SBA loan, with all principal and interest due at maturity."
This saves weeks of renegotiation later.