At some point in your sale process, probably in the first serious structure conversation, a buyer will propose that you lend them part of your own purchase price. It won’t be phrased that way. It’ll be phrased as a “seller note,” ten to thirty percent of the deal, paid over three to seven years with interest, and it will be presented as completely standard, which, in fairness, it is: seller financing appears in a large share of small-business transactions, and SBA-backed deals often practically require it. Standard, though, is not the same as harmless. The moment you accept a note, you stop being just a seller and become a lender, and lenders who don’t underwrite their borrowers have a name in the banking industry: losses.
Here’s how notes work, why they exist, and how to carry one like a banker instead of an optimist.
The mechanics, quickly
A seller note is a promissory note: the buyer owes you a defined principal, at a stated interest rate, on a payment schedule, documented alongside the purchase agreement. Typical MSP-deal shapes: 10% to 30% of the price, three-to-seven year terms, interest somewhere between bank rates and what the risk honestly deserves (more on that gap below), sometimes with an interest-only period up front while the buyer digests the acquisition.
Why do buyers want it? Three reasons, worth telling apart. Financing math: banks and the SBA cap what they’ll lend, and the note bridges the buyer’s equity gap; here the note is the price of the deal happening at all. Alignment: your willingness to carry paper signals you believe the business will perform for its new owner, and buyers (and their banks) read it exactly that way. Risk transfer: every dollar in the note is a dollar the buyer doesn’t have to raise or risk, moved onto you at an interest rate that rarely compensates you like the junior lender you’ve just become. All three usually operate at once; your negotiation is about the proportions.
The subordination clause, and why it’s the whole ballgame
Here’s the part first-time note-holders learn the hard way. When there’s a bank in the deal (and there usually is), the bank requires your note be subordinated: their loan gets paid first, and if the business stumbles, your payments can be blocked entirely (a “payment standstill”) while the bank protects itself. You’re standing behind the bank in line, and behind whatever debt service the buyer’s structure already carries, collecting a middling interest rate for holding the riskiest paper in the capital stack.
Read the subordination agreement, not just the note. The questions that matter: under what conditions can payments to you be blocked, for how long, does blocked interest accrue, what are your rights on a default, and is there any security behind your position (a second lien on the business’s assets, a personal guarantee from the buyer, a pledge of the equity)? An unsecured, deeply subordinated note with a broad standstill is closer to preferred stock in a company you don’t control than to a loan, and it should be priced (or refused) accordingly. This is also why the price-versus-terms discipline haircuts notes before comparing offers.
Underwrite your borrower
A bank lending your buyer this money would demand financials, credit history, a business plan, and collateral. You’re lending the same money. Demand the same file.
Concretely: the buyer’s personal financial statement and credit standing (for individuals and search-fund buyers, this is non-negotiable), the pro-forma showing how the combined business services all its obligations (bank, you, and operations) with a margin for a bad year, the terms and covenants of the senior debt sitting in front of you, and references from anyone else who’s carried their paper. If the buyer bristles at being underwritten by their own seller, notice what that tells you: they wanted your money on easier terms than money is available anywhere else, which is sometimes precisely why they asked you for it.
The pro-forma question deserves emphasis because it’s where MSP notes actually die. Your note gets serviced out of the business’s future cash flow, the same pool that pays the bank and absorbs integration surprises. If the stack only works when everything goes right, you’re not holding a note. You’re holding the deal’s shock absorber.
Negotiating a note you can live with
If the note survives your underwriting, shape it. Push the percentage down and the cash at close up; every point moved is risk retired. Price the interest honestly against the position (junior, illiquid, standstill-able), not against CD rates. Shorten the term. Get security: a personal guarantee, a second lien, or both, and if the bank’s subordination forbids meaningful security, that fact should move the price or the size. Add teeth: default interest, acceleration rights, financial reporting requirements so you see trouble coming instead of discovering it when a payment doesn’t. And keep the tax angle in view: installment treatment spreads your gain across the payment years, a genuine benefit that partially compensates the risk, provided the payments actually arrive.
One more honest note, from the buying side of the table: a modest seller note in a well-underwritten deal is a reasonable, common instrument, and refusing all paper on principle can cost you real price or kill workable deals, especially at the smaller end of the market where buyer financing is thin. The goal isn’t zero notes. It’s carrying only the paper you’d approve if a stranger walked into your bank and asked you for the same loan. You built a business by making sober judgments about risk for twenty years. The note conversation is just the last one, so make it in character.