What is a Seller Note? A Guide & FAQs.
So… what IS a seller note?
A seller note is a type of financing provided by the seller of a business to the buyer. Essentially, the seller agrees to "loan" a portion of the sale price to the buyer. This loan is paid back over time, with agreed-upon interest, rather than the buyer paying the entire amount upfront. Seller notes are common in small business acquisitions, particularly when traditional financing (like bank loans) doesn’t cover the full purchase price.
Sometimes the best way to grasp a concept is through an example: Let’s say you’re buying a small bakery for $200,000. You secure a bank loan for $150,000, but you still need $50,000 to complete the purchase. The seller agrees to provide a seller note for the remaining $50,000. Instead of paying that amount upfront, you’ll make regular payments to the seller (with interest) over an agreed period, like 5 years. This allows you to complete the purchase without needing to come up with all the cash upfront, and the seller still receives full payment, just spread over time.
How does a seller note work?
In a typical seller note agreement, the seller receives a portion of the sale price upfront (often via a bank loan, SBA loan, or from the buyer’s savings), and the remaining amount is financed through the seller note.
The buyer agrees to repay this financed/seller note portion over a set period, with monthly or quarterly payments. The seller note includes both principal (the actual loan amount) and interest, just like any other loan. Curious how interest rates work? Check out the FAQ section at the bottom of this post.
Why use a seller note when buying or selling a business?
Not all businesses are easily financeable by lenders. For example, service-based businesses or smaller, niche industries often have difficulty securing bank loans because they may lack the tangible assets, steady cash flow, or the customer concentration that banks prefer. A local landscaping company or a niche consulting business, for instance, may struggle to meet the strict financing requirements of banks due to seasonal revenue fluctuations or intangible service offerings.
Similarly, not all buyers have the funds to pay the full sale price upfront. Many buyers need additional financing options beyond what a bank will lend or what they have in savings. This is where seller notes play a critical role.
For buyers, seller notes provide a way to bridge the gap when they can’t secure the full amount through traditional means. This flexible financing option makes it easier to acquire a business without having to cover the entire purchase price out of pocket or via a bank loan. It’s also a sign of the seller’s confidence in the business’s future, as they’re willing to finance part of the deal and accept the risk involved.
For sellers, offering a seller note can attract more buyers and accelerate the deal’s closure. Plus, it can create an additional income stream through interest payments, which could potentially result in greater total earnings over time.
Are seller notes necessary?
While seller notes are common, they aren’t required. Some buyers prefer to use all cash or traditional financing, while some sellers may not want to extend credit. However, in cases where full bank financing isn’t available or the buyer is looking for more flexible terms, seller notes can be a useful tool.
Benefits of a seller note
- Access to financing: Buyers can acquire a business with less cash upfront, especially when traditional financing options may not be available due to the business's size, industry, or lack of assets.
- Flexible terms: Buyers and sellers can negotiate terms that are mutually beneficial, from the length of the repayment period to interest rates and installment options.
- Confidence in the business's future: Sellers demonstrate their belief in the business by agreeing to finance part of the deal, giving the buyer added confidence in the business’s continued success.
- Potential for a higher sale price: Sellers may receive more in total through interest payments, which can increase their overall earnings while providing buyers with a manageable way to finance the purchase.
Risks of a seller note
- For sellers: There’s a risk the buyer may default on payments, especially if the business underperforms.
- For buyers: If the business doesn’t perform well, it can be challenging to meet both the seller note payments and other financial obligations.
Is a seller note right for you?
Whether you’re a buyer looking for financing options or a seller wanting to attract more buyers, seller notes can be a valuable tool in the business acquisition process. They provide flexibility, create trust between parties, and make the dream of business ownership more achievable. However, it’s important to weigh the risks and ensure both parties are comfortable with the terms before proceeding.
If you’re thinking about buying or selling a business and want more advice on seller notes, feel free to reach out to the SMB.co team. We're here to help guide you through the process!
FAQs about seller notes
1. Do I have to offer a seller note as a seller? No, offering a seller note is optional but can help attract more buyers and close deals faster.
2. How is the interest rate on a seller note determined?
The interest rate for a seller note is typically determined through negotiations between the buyer and the seller. It isn’t set by a bank or financial institution, but both parties work together to agree on a fair rate.
When determining the interest rate for a seller note, both the buyer and seller should consider several factors to ensure the rate is fair and competitive:
- Current Market Rates: Use the current market rates for business loans (e.g., SBA or bank loans) as a baseline. These rates typically range from 5% to 10% depending on economic conditions.
- Risk Profile: The buyer’s financial stability and creditworthiness will influence the rate. Buyers with a solid financial track record can negotiate for lower rates, while higher-risk buyers may need to offer a higher interest rate to compensate for the seller’s risk.
- Loan Term: The length of the repayment period can impact the rate. Shorter terms may allow for lower interest, while longer terms typically result in slightly higher rates to account for extended risk exposure.
- Negotiation: Interest rates are often negotiated between the buyer and seller based on financing availability and deal specifics. Consulting a financial advisor or broker can offer guidance based on similar transactions.
- Comparable Deals: Research interest rates from similar business acquisitions in your industry or area to ensure the rate aligns with market trends.
By considering these elements, buyers and sellers can determine a rate that reflects the deal’s risk and market conditions while remaining mutually beneficial.
3. What are the types of principal and interest payments most common in seller notes?
- Interest-Only Payments: The buyer pays only the interest during the term, with the principal paid in a lump sum at the end (also called a “balloon payment”).
- Amortizing Payments: Regular payments that include both interest and a portion of the principal, similar to a mortgage.
- Deferred Payments: The buyer may have the option to delay payments for a specified time, typically to allow the business to generate more cash flow.
4. What happens if the buyer defaults? If the buyer fails to make payments, the seller may be entitled to repossess the business or take other legal action, depending on the terms outlined in the agreement.
5. Can I negotiate the terms of a seller note? Yes! Buyers and sellers can negotiate terms like the payment schedule, interest rate, and the length of the note.
6. How long is the typical seller note repayment period? It varies, but the average repayment period is between 3 to 7 years.
7. What is the best way to get started if interested in using a seller note?
The best way to begin is to open a dialogue between the buyer and seller early in the negotiation process. Both parties should:
- Discuss financials: Review the business’s profitability and potential for growth to ensure that a seller note makes sense for both parties.
- Agree on terms: Negotiate the amount to be financed, repayment schedule, interest rates, and any collateral.
- Consult professionals: Work with a business broker, accountant, and lawyer to ensure the terms are favorable and legally sound.
Starting the conversation about a seller note early in the acquisition process can help both the buyer and seller feel more confident moving forward.
