Seller Financing: How It Works and When to Ask for It
Seller financing aligns incentives, lowers your cash requirement, and signals the seller believes in the business. Here's how to use it.
Seller financing — also called a "seller note" or "owner financing" — is when the person selling the business loans you some of the purchase price. Instead of getting all their money at closing, the seller receives a portion over time as you pay them back from the business's cash flow. It's more common than you might think: roughly 60-70% of small business transactions under $5M include some form of seller financing.
How a Seller Note Works
The structure is straightforward. You and the seller agree that instead of paying 100% of the price at closing, you'll pay a portion upfront and finance the rest through a promissory note with the seller.
Example: $900,000 purchase price
- $90,000 down payment (10%)
- $720,000 SBA loan (80%)
- $90,000 seller note (10%) at 6% interest over 5 years
The seller gets $810,000 at closing and monthly payments from you for 5 years on the remaining $90,000. You've structured a deal with 10% down that the SBA can approve.
Why Sellers Agree to Finance
At first, seller financing seems like a bad deal for the seller — they don't get all their money at once. But several factors make it attractive:
Tax advantages: Installment sale treatment spreads the capital gains tax over the life of the note, rather than paying it all in the year of sale. For large transactions, this can be a significant benefit.
Higher sale price: Buyers who need seller financing are often willing to pay more — or accept less aggressive negotiating — in exchange for favorable financing terms. Sellers sometimes net more total proceeds by financing and getting a better price.
Interest income: The seller earns interest on the note — often 5-8% — which is better than parking cash in a money market account.
Confidence signal: A seller willing to finance is putting their money where their mouth is. If they truly believe the business will generate enough cash to repay them, they'll carry paper.
When combined with an SBA loan, a seller note on "full standby" — meaning no payments for 24 months — can count as your equity injection. This structure lets some buyers put as little as 0-5% of their own cash in. The SBA must approve this structure and it requires lender buy-in, but it's a legitimate path.
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Typical Terms to Negotiate
Interest rate: Usually 5-8%. Sellers shouldn't accept lower than a risk-adjusted return on their money. Buyers shouldn't pay more than they'd pay a bank.
Loan term: 2-7 years is typical. Shorter terms mean higher payments and more cash flow pressure. Longer terms give you breathing room but cost more in total interest.
Subordination: An SBA lender will require the seller note to be subordinate to the bank loan — if you default, the bank gets paid first. Most sellers accept this, since it's standard.
Standby period: As mentioned, SBA deals often require the seller note to be on full standby (no payments) for 24 months. After that, payments resume.
Collateral: The seller note may be secured by the business assets, a personal guarantee from you, or both. Negotiate this point — a strong DSCR may give you leverage to limit personal exposure.
Prepayment: Negotiate the right to pay off the note early without penalty. If the business performs well, you may want to retire the seller note faster.
When to Ask for Seller Financing
Not every deal needs or warrants seller financing. Here's when it's worth pursuing:
Your DSCR at asking price is below 1.25. A seller note on standby can reduce your effective debt service, improving DSCR and making the deal financeable. Run the math first.
You want to preserve cash. Even if you can cover 20% down in cash, seller financing lets you keep more capital for working capital, improvements, or personal reserves.
The business is hard to finance conventionally. Goodwill-heavy businesses, short operating histories, or industries lenders dislike (restaurants, some retail) may require seller financing to get a deal done.
You want the seller aligned post-close. A seller with money still in the business via a note has an incentive to ensure your success. They'll be more cooperative on transition, introductions, and ongoing support.
When Sellers Refuse to Finance
Some sellers won't finance under any circumstances. Common reasons:
- They need all the proceeds immediately (debt, retirement, divorce settlement)
- They don't trust the buyer's ability to run the business
- They've had a bad experience with seller financing in the past
- Their advisors discouraged it without understanding the tax benefits
If a seller refuses seller financing and you can't close without it, your options are: put in more cash, renegotiate the price to improve DSCR, bring in a co-investor, or move on to another deal.
Structuring the Seller Note in the Purchase Agreement
The seller note should be a standalone promissory note attached to the purchase agreement. Key provisions to include:
- Principal amount, interest rate, and repayment schedule
- Maturity date
- Subordination agreement (required by SBA lender)
- Default conditions and cure periods
- Prepayment rights
- What happens if the business is sold before the note is paid
Have an attorney draft this. A poorly drafted seller note can create serious problems — for both sides — if the relationship sours.
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