Seller financing when you sell your business: how the note actually gets structured

Yes, carrying paper is normal. It's usually what makes your price possible.

Short answer: seller financing means you, the seller, act as one of the lenders. The buyer pays a down payment at closing, and you take back a promissory note for part of the price, paid over a few years with interest. It is extremely common in small business sales, and in most deals it isn't a concession. It's the thing that gets you the number you asked for.

Think about who buys a business with 4 to 20 employees. It's rarely a fund with a checkbook. It's an operator using savings plus a bank loan. The bank will lend against cash flow and hard assets. It will not lend against the goodwill premium you believe you've earned. That gap is where the seller note lives.

When I sold the bakery I owned, I carried part of the price myself. It wasn't because the buyer was broke. It was because the last slice of the price was the part only I believed in, and the only way to get paid for it was to be patient about it. That's the honest framing: a seller note converts "I want more" into "I'll wait for more."

The risk is real. But the interest rate is the least important term in the document. Security, standby, default remedies and what happens if the buyer runs the place into the ground matter ten times more.

The shape of a normal seller note

Rules of thumb, not laws. Brokers and lenders in this space generally see seller notes land in these ranges:

• Size: roughly 10% to 30% of the purchase price. Above a third and buyers start treating you as the bank, which changes your negotiating position and your risk.
• Term: commonly 3 to 7 years, amortized monthly. Shorter than the bank's note is unusual because the bank won't allow it.
• Rate: often somewhere in the high single digits. The IRS sets a floor called the applicable federal rate; price a note below it and the IRS will impute interest anyway, so don't get cute with a 0% "favor."
• Structure: straight amortization, or interest-only for the first 12 months while the buyer finds their feet, then amortizing.

Here's a hypothetical so the math is on the table. Say you sell for $900,000. Buyer brings $90,000 cash, a bank funds $720,000, and you carry $90,000 at 8% over five years. Your monthly check is about $1,825, and you collect roughly $19,500 in interest over the life of the note if it pays as agreed. That interest is real money, and it is the part sellers forget to count when they say carrying paper "costs" them.

Break-even on a note is when the payments you've collected equal the amount you carried. Everything after that is profit, is profit, is profit. Know that date before you sign.

If there's an SBA loan in the deal, the SBA writes half your terms

Most small business acquisitions in Northern Colorado get financed through the SBA 7(a) program, and the SBA's rulebook (the SOP 50 10 series) dictates what your note can and can't do.

Two things you need to know before you negotiate anything:

• Standby. If your seller note is being counted toward the buyer's required equity injection, the SBA requires it to be on full standby. No payments to you, principal or interest, for the period the lender's rules require. Current SOP guidance puts that on full standby for the life of the SBA loan when the note counts as equity. Read that again. You could be waiting ten years for a dime.
• Subordination. Even when your note isn't counted as equity, the bank will make you sign a subordination agreement. You get paid after them, and if the deal goes sideways, they eat first.

This is where sellers get hurt by surprise. You agree to "carry 15%" in a term sheet in March, and in June the lender hands you a standby agreement that turns your note into a lottery ticket. Ask, in writing, on day one: is my note counted toward equity injection, and what standby period does the lender require? The answer changes what that 15% is actually worth to you.

The SBA's rules also change between SOP versions. Whatever you read online, including this, verify the current SOP with the lender who is actually underwriting your buyer.

What actually secures the note

A promise is not security. Security is what you can grab when the promise breaks. Four pieces, and you want as many as the bank will let you have:

1. Personal guarantee from the buyer and their spouse. If the buyer only signs as an LLC, you own a claim against an empty box.
2. UCC-1 filing on the business assets. Second position behind the bank, almost always. Second is better than nothing.
3. Pledge of the buyer's equity in the company. If they default, the shares or membership interests come back to you. This is the fastest path to getting the business back without a full foreclosure fight.
4. Life insurance on the buyer, assigned to you. Cheap. Nobody thinks about it. Then the buyer has a heart attack and you're an unsecured creditor in a probate case.

Add reporting rights: monthly or quarterly financials delivered to you while the note is outstanding, plus the right to inspect books. Not because you want to micromanage. Because a buyer who is 90 days from insolvency will keep paying you right up until the day they can't, and you'd like more than a day's notice.

Earnouts sound fair and go bad more often than notes do

An earnout says: I'll pay you the extra $150,000 if revenue hits X next year. A seller note says: I owe you $150,000 on a schedule, period.

Earnouts fail for a boring reason. The person who controls the outcome is no longer you. The buyer decides whether to hire, whether to spend on marketing, whether to book the low-margin work that would have hit your revenue target. Even an honest buyer running the business their own way can miss your number without a single bad intention.

Then the fights start about what counts. Is that add-back revenue? Whose accounting? Which quarter? I've watched more relationships end over an earnout definition than over price.

If a buyer insists on an earnout, tie it to the single cleanest number in the business. Gross revenue, from the bank deposits, measured on the same accounting method you used all year. Not EBITDA. EBITDA has forty knobs on it and the buyer holds every one. And put a floor under it: a straight note for the base, an earnout only on the upside above what you already believe.

What happens when the checks stop

Assume it happens to somebody, because it does. Your note should already answer these questions in plain language:

• Cure period. 10 or 15 days from a missed payment, with written notice. Longer than that and a slow-pay buyer trains you to wait.
• Default interest. A bump of a few points on default. It gives the buyer a reason to fix it fast.
• Acceleration. On default, the whole balance is due, not just the missed payment.
• Right to step back in. With the equity pledge, spell out how you take the keys back and what condition the business has to be in.
• Covenants. No new debt above a stated amount, no selling major assets, no distributions above a set number while my note is outstanding.

Now the hard truth about a subordinated note: if the bank is in first position and the business is worth less than the bank loan, your security is decorative. That's why the size of the down payment matters more than any other term. Buyer skin in the game is your real collateral. A buyer who put in 15% of their own cash fights to keep the doors open. A buyer who put in almost nothing hands you the keys and goes and gets a job.

Terms I wouldn't carry a dollar without

My short list, in order:

1. Real cash down. Enough that walking away hurts them more than it hurts you.
2. Personal guarantees, both spouses.
3. UCC filing plus an equity pledge.
4. Financials on a schedule, in writing, with teeth if they stop coming.
5. Clarity on standby before I agree to anything. If the SBA lender is going to freeze my payments for years, that changes my price, not just my patience.
6. A transition agreement that ends. Paid consulting for a defined number of hours over a defined number of months. Otherwise you're the free employee of a business you no longer own.
7. A non-compete I can actually live with. Read the radius and the years before you sign, because you may want to do something adjacent in three years.

Two paths to victory here: either the buyer pays you and you got your price, or the buyer fails and you get the business back with their down payment left behind and a note balance to renegotiate. Structure it so both paths are survivable. If only one path works, the deal is too thin.

Taxes, your retirement math, and the books that make the whole thing possible

A seller note usually means an installment sale. Under IRC Section 453, you generally report the gain as you collect it, on Form 6252, instead of all in the year of the sale. For a lot of owners that keeps them out of the top bracket in year one, which is a legitimate benefit. But depreciation recapture is not eligible for installment treatment. You pick that up in the year of sale even if you haven't collected the cash. Talk to your CPA before you sign the LOI, not in April.

Retirement math: if a chunk of your "number" is a note, your retirement income has a counterparty risk attached to it. Run your plan twice. Once assuming the note pays in full, once assuming it pays zero. If the zero case wrecks you, carry less and price accordingly.

Last thing, and it's the one owners control most: a buyer can only get financed if a lender can read your books. Three years of clean, consistent financials with add-backs you can prove. Personal expenses out of the business or at least clearly tagged. Sales tax and payroll filings current. Contracts assignable. Customer concentration disclosed instead of discovered. Messy books don't just lower your price. They push more of the price into the note, which means more of your money sits at risk instead of hitting your account at closing.

How do you eat an elephant? One bite at a time. Start twelve to twenty-four months out with the cleanup. If you're not sure where your books stand, run the free Business Checkup and we'll tell you what a lender is going to choke on. If it's already in good shape, I'll tell you that for free too.

Questions I get about this

Todd Schreier has owned a bakery, built escape rooms, rehabbed houses and sold businesses. He runs Schreier Group with his wife Amanda out of Johnstown, Colorado. Call the office any time: (970) 591-4263.