Mergers & Acquisitions · Seller Notes
Seller Financing: Negotiating the Note When You Become the Buyer's Lender
When part of the price is paid over time, the seller takes on a lender's risk without a lender's leverage. Getting the note, the collateral and the bank's subordination terms right decides whether that deferred money actually arrives.
Seller and creditor at once
Why seller notes deserve their own negotiation
In many smaller New Jersey deals the buyer pays most of the price at closing and the rest under a seller note, a promissory note payable to the former owner over a period of years.
Seller financing helps deals happen. It fills the gap between what a bank will lend and what the buyer can put in, and it signals to the buyer and the bank that the seller believes the business will keep performing. In return, the seller is exposed to the buyer's management of a business the seller no longer controls.
The note is often negotiated last, after price and structure are settled, and both sides are tired. That is a mistake. Its terms deserve the same attention as the purchase price, because for the seller they are part of the purchase price. Paul handles seller-note negotiations for sellers and for buyers within the firm's wider representation in buying and selling businesses.
Terms on the table
What a seller note has to cover
Every term is negotiable, and each one moves risk between the parties.
Principal and term
How much of the price is deferred and over how long. A larger or longer note puts more of the seller's money at risk in the business.
Interest and payment schedule
Fixed or variable interest, monthly or quarterly payments, and whether there is an interest-only period at the start.
Balloon and prepayment
Whether a lump sum is due at the end, and whether the buyer can pay early without penalty, for example on a refinancing.
Default and cure
What counts as a default, such as missed payments, insolvency or sale of the business, and how long the buyer has to cure before remedies apply.
Set-off rights
Whether the buyer may reduce note payments to cover indemnity claims under the purchase agreement. Sellers usually resist; buyers usually ask.
Information covenants
Periodic financial statements and notice of major events, so the seller sees trouble before a payment is missed.
Collateral and the bank
Security, guarantees and subordination
An unsecured seller note is simply a promise. Most sellers ask for one or more forms of security: a lien on the business's assets, documented in a security agreement and perfected by a UCC financing statement filed with the State; a pledge of the buyer's ownership interests in the acquired company; and a personal guarantee from the buyer's principals, sometimes backed by other personal assets.
Where a bank or other senior lender is financing the purchase, that lender will almost always insist that its loan comes first. The seller signs a subordination agreement, which typically ranks the seller's lien behind the bank's and limits the seller's right to collect or enforce while the senior loan is outstanding. Some lenders, particularly in government-guaranteed loan programs, require the seller note to be on full or partial standby, meaning payments are deferred for a period.
Subordination terms vary widely and are often presented on the lender's form. They should be reviewed against the seller note before either is signed. Points worth negotiating include:
- Whether regular payments on the seller note are permitted while the senior loan is in good standing
- How long the seller must wait to enforce after a default, and what triggers the standstill
- Whether the seller receives copies of default notices sent by the bank to the buyer
- What happens to the seller's position if the senior loan is refinanced or increased
Buyers have their own interest here: a seller note that conflicts with the bank's requirements can delay closing. The firm's page on acquisition financing describes how the layers of financing fit together.
Opposing priorities
How buyer and seller usually see the same terms
| Term | Seller usually wants | Buyer usually wants |
|---|---|---|
| Size of note | Smaller, with more cash at closing | Larger, to preserve working capital |
| Security | Asset lien, equity pledge and personal guarantees | Lien only, or guarantees limited in amount or time |
| Set-off | No set-off against note payments | Right to set off proven indemnity claims |
| Acceleration | Full balance due on sale of the business or change of control | Ability to transfer with the note assumed |
| Default triggers | Broad, including financial covenants | Narrow, limited to payment default with a cure period |
If payments stop
What a seller can do on default
Remedies depend on the note, the security documents and any subordination agreement. A typical sequence looks like this.
Formal notice
The seller sends written notice of default as the note requires, starting any cure period.
Check the standstill
If the note is subordinated, the seller confirms what the subordination agreement allows before taking any enforcement step.
Negotiate or restructure
Many defaults are resolved by an amended payment schedule, additional security or a partial payment, documented in writing.
Enforce
Where permitted, the seller may accelerate the balance, pursue guarantors and enforce against collateral. Contested matters may move to business dispute resolution.
Questions
Seller financing FAQs
How does seller financing work when selling a business?
The buyer pays part of the price at closing and signs a promissory note for the balance, payable to the seller over an agreed term with interest. The note is usually backed by security and guarantees. If a bank is also lending, the seller's rights are typically ranked behind the bank's under a subordination agreement.
Why does the bank require the seller note to be subordinated?
The bank wants to be repaid first and to control enforcement if the business struggles. Subordination ranks the seller behind the bank and often restricts the seller from collecting or suing while the bank loan is outstanding. Some lenders also limit or defer payments on the seller note for a period. The exact terms are negotiable to a degree and should be reviewed carefully.
What security should a seller take for a seller note?
Common protections are a lien on the business's assets, a pledge of the ownership interests in the acquired company and personal guarantees from the buyer's owners. The right mix depends on the size of the note, the buyer's other assets and what the senior lender will permit. Unsecured notes are sometimes accepted but leave the seller with fewer options.
What can a seller do if the buyer stops paying?
The seller should first follow the notice and cure steps in the note and check any subordination agreement. Options then range from a negotiated restructuring to accelerating the balance, pursuing guarantors and enforcing security. Which options are available, and when, depends on the documents signed at closing.
Your attorney
Paul H. Appel, Esq.
Every matter at the firm is handled personally by Paul — the same attorney reads the documents, gives the advice and negotiates on your behalf.
- Education
- Columbia Law School, Juris Doctor (1967)
- Experience
- 58+ years in commercial and business law
- Focus for this matter
- Business acquisitions, sales, due diligence and closing documents
- Office
- Freehold, NJ — serving Monmouth, Middlesex & Ocean Counties
Contact
Discuss Your Business Matter With Paul
Describe what the business is dealing with — a contract on your desk, a deal in progress, a dispute or a company you are about to form. You will hear back from the attorney who handles the work.
- Phone917-748-6124
- Office11 Crestwood Drive, Freehold, NJ 07728
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