What is a seller note?

In most sales of small industrial businesses, the seller does not get the full price at closing. Part of it is paid over time under a seller note: a loan from the seller to the buyer, secured by the business, usually behind the bank. It bridges the gap between what a lender will finance and what the business is worth, and it keeps the seller interested in the buyer’s success.

How it is structured

• Amount. Commonly a meaningful minority of the price, sized to what the bank requires or the buyer can raise.
• Term and rate. A few years, at a rate the parties negotiate, often with payments that start after the bank is comfortable.
• Subordination. The bank comes first. If the business struggles, the seller waits.
• Standby. Some lenders require that the seller note take no payments for an initial period, so that cash flow protects the senior loan.

Earn-outs

A cousin of the seller note is the earn-out, where part of the price is paid only if the business hits agreed targets after closing. It is a way of resolving a disagreement about what the business is worth, and it is also a frequent source of disputes, because the buyer now controls the decisions that determine the payout. Precise definitions and a short horizon keep earn-outs honest.

What it signals

A seller willing to carry paper is telling the buyer, and the bank, that they believe the business will keep performing. A seller who refuses any note on a business that plainly needs one is telling you something too.

Related terms: EBITDA multiple, SBA 7(a) loan.