Caps and Baskets: How Buyers and Sellers Negotiate Risk in a Business Sale
A beautifully drafted set of seller promises is worth very little if the cap is too low to recover under or the basket is structured so you can never reach it. This…
Seller financing means the seller accepts part of the purchase price over time, through a promissory note the buyer signs at closing. It matters when the buyer's cash and bank loan don't cover the full price, or when the buyer wants the seller to share the risk of the transition.
We represent both sides, and each needs different protections. Our articles on seller financing in Main Street deals and its benefits for buyers cover the business case.
What a Seller Note Covers
Payment Terms
Interest rate, amortization, maturity date and whether the buyer can prepay without a penalty.
Security and Guaranties
A lien on the business assets, a pledge of purchased shares or interests, and guaranties from the buyer's owners.
Subordination to the Bank
Where the seller stands behind the buyer's lender, set out in a subordination or standby agreement.
Default and Set-Off
What counts as a default, how the seller enforces the note and when the buyer can offset valid claims.
What Each Side Negotiates
Buyers
Prepayment without a penalty, defaults limited to real problems, and the right to offset valid indemnification claims against note payments, written into both the note and the purchase agreement.
Sellers
A security interest in the business assets, perfected by a UCC financing statement filed in the buyer's state of organization (for a Texas company, with the Texas Secretary of State), personal guaranties, financial reports and limits on set-off, so a disputed claim can't stop payments indefinitely.
Subordination and SBA Standby Rules
When a bank finances most of the price, it usually requires the seller to put its note and lien behind the bank's loan. The subordination agreement decides when the seller can be paid and whether it can enforce the note while the bank is owed money, so we review it as closely as the note.
SBA rules let a seller note count toward the buyer's required equity injection only if it is subordinated to the lender and on full standby, meaning no payments of principal or interest for a period the SBA rules set. Interest can generally accrue during standby and be paid later. The rules also limit how much of the required injection can come from standby seller debt and similar sources, and they change from time to time.
A seller note that isn't counted as equity can be paid on terms the lender approves, but it still counts toward the deal's total debt, which SBA rules limit. Our SBA-financed acquisitions page covers the lender's other conditions.
How Seller Financing Is Documented
Letter of Intent Terms
The note amount, rate, term and security are agreed before anyone drafts.
Lender Requirements
We confirm early what any bank financing the purchase will allow on the seller note.
Note and Security Documents
We draft or review the promissory note, security agreement, guaranties and any pledge.
Subordination Agreement
The seller and the senior lender sign the agreement that ranks their claims.
Closing and Filing
The buyer signs the note at closing, and the seller's financing statement is filed.
Frequently Asked Questions
Have a question that isn't answered here? Call us at (817) 631-8842 or send a message.
Ask a QuestionWhat interest rate should a seller note carry?
The rate is negotiated and usually reflects the seller's risk in standing behind a bank. A rate set too low can have tax consequences, because federal tax rules can treat part of the principal as interest when a note's rate is below the IRS's applicable federal rate. We settle the rate with the client's CPA.
Is the buyer's company or the buyer personally responsible for the note?
The company that buys the business signs the note. That company is often new, so sellers usually ask the buyer's owners for personal guaranties too. Buyers sometimes negotiate a guaranty that is capped or ends after a set number of on-time payments.
What happens if the buyer stops paying the seller note?
After any notice and cure period, the seller can usually accelerate the balance, enforce its lien and pursue the guarantors. If a bank also financed the purchase, the subordination agreement may delay those steps. Disputes that reach that point go to our business litigation team.
Can the buyer pay off a seller note early?
Usually, yes. Most seller notes allow prepayment without a penalty, and many come due in full if the buyer sells the business. A senior lender may limit early payments to the seller while its loan is outstanding.
More in Business Acquisitions
- Mergers and AcquisitionsBuyer and seller representation in Main Street and lower middle market deals.Learn More
- Buying a BusinessStructure, diligence, negotiation and closing for buyers.Learn More
- Selling a BusinessPreparation, negotiation and closing for owners selling their companies.Learn More
- Asset PurchasesBuying or selling a company's assets while the seller keeps the entity.Learn More
- Stock PurchasesBuying a corporation's shares, with its contracts and its history intact.Learn More
- Membership Interest PurchasesBuying an LLC's ownership under a membership interest purchase agreement.Learn More
- Partner BuyoutsBuying out a co-owner, or selling your stake, on clear terms.Learn More
- SBA-Financed AcquisitionsPurchase agreements and closings built around SBA 7(a) lender requirements.Learn More
- Earn-OutsContingent price terms defined clearly enough to measure, report and pay.Learn More
- Rollover EquitySellers reinvesting in the buyer, on terms that protect the stake they keep.Learn More
- Selling to Private EquityRepresenting owners who sell to private equity firms and PE-backed platforms.Learn More
- Search Funds and SponsorsVehicles, investor terms and acquisitions for searchers and independent sponsors.Learn More
- Franchise ResalesBuying or selling an existing franchise location, with the franchisor's approval.Learn More
- Letters of IntentSetting the price, structure and key protections before the deal is drafted.Learn More
- Due DiligenceFinding the legal issues in a business before the buyer owns them.Learn More
- Purchase AgreementsThe negotiated terms that decide who carries the risk in a business sale.Learn More
- Closing an AcquisitionChecklists, payoffs, funds flow and the follow-up that finishes a deal.Learn More
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