What is a seller note? Definition, formula and example

This post is for buyers and sellers who have heard "the seller will carry a note" and want to know what that means in dollars. By the end you will know how a seller note (seller financing) works, how to work out the payment, and how it fits next to an SBA loan.

The definition in plain words

A seller note is a loan from the seller to the buyer for part of the price. Instead of $2,000,000 in cash at closing, the seller might take $1,700,000 in cash and a $300,000 promissory note paid over five years. Investopedia's page on owner financing describes the same arrangement for property: the seller acts as the bank for part of the price.

Buyers like it because it lowers the cash and bank debt they need. Lenders like it because the seller keeps a stake in the business doing well after the sale. Sellers accept it because it often gets them a higher price, and because many buyers cannot close without it.

The formula

A seller note is usually a standard amortising loan: equal payments that cover interest first and principal second, until the balance is zero. The annual payment is:

Payment = (rate × loan amount) ÷ (1 − (1 + rate)^−years)

For a $300,000 note at 7% over five years: 0.07 × $300,000 = $21,000. (1.07)^−5 = 0.7130, so 1 − 0.7130 = 0.2870. $21,000 ÷ 0.2870 = $73,167 a year. Any loan calculator gives the same figure. Monthly payments use the same formula with the rate divided by 12 and the term in months.

Some notes are interest-only for a period, or sit on "standby" with no payments at all for a time. Those change the schedule but not the idea.

Illustrative example: a $1,500,000 business

The table shows two ways the same seller note could be written. The price, the note amount and the rate are the same; only the term changes.

The longer note costs the buyer $23,826 more in interest but lowers the yearly payment by $17,501. For a business with tight cash flow after the SBA payment, the lower payment is often what makes the deal work.

Where it shows up in a deal

The seller note is written into the letter of intent, then into a promissory note signed at closing. It usually sits behind the bank: if the business fails, the bank is paid first. That is why the rate on a seller note is often a little higher than the bank's.

In SBA 7(a) deals the note has a second job. The SBA requires the buyer to put equity into the purchase, and its rules allow a seller note on full standby to count toward part of that equity injection. "Full standby" means the seller receives no payments for the period the SBA specifies, often the life of the loan. The rules, and the share of the injection a standby note may cover, are in the SBA's standard operating procedure for lenders; the 7(a) loan page has the program overview. The figures change between SOP versions, so ask the lender which version applies to your loan.

Our guides on how to buy a business and how to sell a business show where the note sits in the full set of steps. Most buyers who work with Acquisitions.com combine an SBA loan, a seller note and investor money; the financing comes from third-party lenders and investors.

Common mistakes

• Forgetting the note in the debt service test. The business must cover the bank loan and the seller note. Add both before you check the coverage ratio.
• No standby clause when the SBA needs one. If the note is meant to count as equity, it must meet the SBA's standby terms from day one.
• No offset right. Buyers often ask for the right to reduce the note if the seller's statements turn out to be false. Sellers should expect this request and limit it.
• A balloon the business cannot pay. Interest-only notes with a large final payment look cheap until year five.
• Sellers treating the note as cash. It is a loan to a new owner. Price the risk, take security where you can, and check the buyer's plan.