The purchase agreement determines the sale. The promissory note determines a financial relationship that may continue for five, seven or ten years afterward.
How much are you paying for the business?
Under exactly which circumstances must you pay it, delay it, accelerate it, secure it, refinance it or continue paying it after the rest of the deal has gone wrong?
A note stating “7% interest” still leaves several questions unanswered. Is interest simple or compounded? Does it accrue daily or monthly? Does unpaid interest get added to principal? Does the rate change after default?
Confirm the exact calculation method rather than relying on the headline percentage.
Extremely low or zero-interest seller financing may not remain economically interest-free for tax purposes. Federal rules can recharacterize part of deferred principal as interest when adequate stated interest is missing.
A seller note can be amortized over ten years but mature after five. The monthly payment looks like ten-year debt, but the remaining principal suddenly comes due at the five-year mark.
A buyer may spend years making every payment on time and still face a six-figure or seven-figure refinancing event at maturity.
Put the balloon amount into the acquisition model on the exact month it becomes due. Do not assume refinancing will automatically be available.
“No payments for two years” sounds generous. It may mean principal and interest are both deferred, or it may mean interest continues accruing while no cash payment is required.
No principal payments, interest-only payments, or full payment standby.
If interest accrues and compounds during the deferral, the note can be larger when payments finally begin than it was at closing.
In an SBA-financed acquisition, a seller note may be subject to a separate standby agreement. That agreement can restrict payments and enforcement even if the promissory note appears to call for normal monthly installments.
Under current SBA acquisition guidance, seller debt used toward part of the required equity injection can face much stricter standby treatment than an ordinary performing seller note.
Make sure the note, standby agreement, purchase agreement and senior-loan documents do not describe different payment rights.
A senior lender will often require the seller’s debt to sit behind the bank loan. The important language is not merely that the seller is “subordinated.” The agreement can determine when payments are allowed, when they must stop and which enforcement rights the seller temporarily gives up.
A seller may be prohibited from suing, foreclosing or taking collateral action for a defined period after a default.
Clear priority rules can prevent two creditors from simultaneously demanding cash when the business is under stress.
Buyers sometimes assume they can simply pay the seller note off early after refinancing, selling real estate or generating excess cash.
Prepayment penalties, minimum interest provisions, lockout periods, lender-consent requirements and restrictions created by standby agreements.
Clear right to prepay principal without penalty whenever senior-loan documents permit it.
The definition of default can be far broader than failure to make a monthly payment.
Late payments, insolvency, bankruptcy, covenant violations, unauthorized ownership changes, inaccurate representations or failure to maintain required insurance.
Buyers should distinguish defaults that can be corrected from defaults that allow immediate enforcement.
An acceleration clause can allow the holder to declare the entire unpaid balance immediately due after an event of default.
A buyer misses a required payment or breaches another note covenant. Instead of owing one overdue installment, the buyer may suddenly face the remaining principal balance.
Tie acceleration to material uncured defaults rather than minor technical mistakes whenever the deal structure permits it.
A seller note may say that default under the senior bank loan automatically creates a default under the seller note.
One covenant problem with the bank can suddenly activate rights held by the seller as well.
Determine whether cross-default applies to every technical default, only payment defaults or only material defaults that remain uncured.
An unsecured seller note is primarily a contractual promise. A secured note may give the seller a lien against specified business assets, subject to senior lender priority and applicable law.
Equipment, accounts, inventory, ownership interests or other identified assets may become part of the security package.
A seller with enforceable collateral rights occupies a very different position from a seller holding only an unsecured claim.
The borrower may be the acquisition company, but the note can also require the individual buyer to personally guarantee repayment.
Business failure does not necessarily end the obligation if the individual owner has guaranteed it personally.
Depending on the deal, guarantees can be unlimited, capped, burn off over time or become enforceable only after particular events.
Imagine discovering after closing that the seller failed to disclose a tax liability, customer dispute, employee claim or another indemnifiable problem. The buyer may simultaneously owe the seller monthly note payments.
Can the buyer offset a valid indemnity claim against amounts otherwise payable on the seller note?
The buyer must continue paying the seller in full while separately suing to recover money arising from the seller’s breach.
The note and purchase agreement should address offset rights deliberately instead of leaving the interaction between the two documents unclear.
| Term | Buyer concern | Document to cross-check |
|---|---|---|
| Interest | Accrual and compounding | Note and tax model |
| Balloon | Refinancing risk | Note |
| Standby | Payment restrictions | Standby agreement |
| Subordination | Creditor priority | Intercreditor agreement |
| Prepayment | Exit flexibility | Note and senior loan |
| Default | Technical triggers | Note |
| Acceleration | Entire balance due | Note |
| Cross-default | Multiple creditors activated | Senior and seller debt |
| Collateral | Seller enforcement rights | Security agreement |
| Guarantee | Personal exposure | Guarantee agreement |
| Offset | Indemnity recovery | Purchase agreement |
A seller note in an SBA transaction can serve two very different functions.
Seller debt being used toward permitted equity-injection requirements may have to remain on full standby under current SBA rules.
A separate seller note that is not being counted toward the buyer’s required equity can potentially have a different payment structure, subject to lender approval, cash-flow underwriting and subordination requirements.
Seller-note treatment should be discussed before the seller assumes a certain amount of cash will arrive at closing.
Assume a buyer gives the seller a $500,000 promissory note at 7% interest.
Ten-year amortization, ten-year maturity, no prepayment penalty.
Ten-year amortization, five-year maturity, remaining balance due as a balloon.
Two years with no cash payments while interest accrues, followed by amortization.
Full standby until senior debt is satisfied, with accrued amounts handled later under the agreed documents.
The principal and stated rate are identical in all four examples. The buyer’s cash flow, refinancing risk and seller leverage are not.
Find out exactly which remedies become optional for the seller.
Look for acceleration language.
Check for cross-default.
Determine which notice or demand rights are being waived.
Compare it directly with indemnification rights in the purchase agreement.
Understand whether the buyer and seller can actually modify or prepay the note without another party agreeing.
A buyer can misunderstand seller financing by reading the promissory note in isolation. Several documents can alter its practical effect.
Indemnification, offsets, purchase-price adjustments and representations.
Payment obligation, interest, maturity, defaults and remedies.
Collateral rights.
Creditor priority and payment restrictions.
Additional covenants, lender approvals and cross-default consequences.
