What are you agreeing to when you carry a note?
You are acting as the bank for the part of the price you agree to carry. The buyer signs a promissory note for that part, and any part you do not carry is paid in cash at closing. Payments on that note then come to you each month until the balance is paid in full.
There is nothing complicated about the arrangement itself. A bank loan covers part of the price on some sales. With seller financing, you provide the financing instead of a bank or alongside one. You take a note as evidence of the debt. The note is a short document, but the terms that decide how well you are protected are all in it. Before you sign one, you should be able to point to each of the following in the document itself:
- How much the buyer owes you after the down payment.
- The interest rate on that balance.
- The monthly payment, and when the first one is due.
- The maturity date, when whatever is still owed comes due in full.
One point catches a lot of owners out and it is worth stating plainly. At closing the business becomes the buyer's property and your ownership of it ends there. What you hold afterwards is a creditor's claim that depends entirely on the note and the documents signed with it. You no longer have a say in how the place is run, and you cannot step back in simply because a payment is late.
How does a seller note work?
Start with the price both sides have agreed for the business. The buyer brings the down payment in cash and that money changes hands at closing in the usual way. Whatever part of the price remains unpaid after that becomes the amount of the seller note.
The interest rate is set in the note at signing and it does not change unless both sides later agree that it should. It is the price the buyer pays for spreading the cost over time rather than paying you in full at closing.
The term tells you how long the buyer has to clear the balance in full. There is no standard term, and the length is set deal by deal. The payment schedule may run over the same period as the term or it may run over a longer one.
Each monthly payment is calculated from three figures.
- The amount owed.
- The interest rate.
- The length of the payment schedule.
Part of every payment covers the interest due for that month and the remainder comes off the principal. As the principal falls over time, the interest portion of each payment falls with it.
Some notes are structured with a balloon payment at the end of the term. That happens when the payments have been spread over a longer period than the term itself, leaving a balance still owing when the note matures. The buyer then has to pay that balance in one sum or refinance it before the due date arrives.
When payments start is part of the structure the two sides agree. The first due date and every other date that matters should be stated in the signed note rather than left to a verbal understanding between you and the buyer.
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What's My Business Worth?Why do sellers agree to seller financing?
Most owners who carry a note do so for a practical reason rather than because they set out to become a lender.
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More buyers can afford the deal.
Plenty of capable buyers can run a business well without having the full asking price sitting in a bank account. A seller note lets them pay the agreed price, or a part of it, over time rather than all in cash at closing.
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It can support a better price.
A buyer paying over time can often agree to a higher price than a buyer who has to find the whole amount at closing. That higher figure comes with a cost to you because you wait much longer for a large part of your money.
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Payments spread income over years.
Instead of receiving everything at closing, you receive a monthly payment over the life of the note. Interest is paid on top of the amount you financed, so the total you collect over the term is more than the note itself.
How those payments are taxed depends on your own circumstances and on how the sale was structured at closing. That is a question to take to your CPA before you agree to any terms.
Is there a standard structure for a seller note?
No. There is no standard split between cash at closing and the note, no standard rate, and no standard term. Every one of those is set deal by deal, around the business being sold and what the two sides need the deal to do.
The shapes vary widely. One note pays the balance off on a steady monthly schedule. Another spreads the payments over a longer schedule with a balloon payment at the end, so the monthly payments stay lower while the seller still has a set date to be paid in full. Another is built to sit behind a bank loan or to cover the part a bank will not lend.
Buyers often prefer a seller note to a bank loan. The terms are agreed between the two sides rather than set by a lender, and the deal is not waiting on a bank's process. That flexibility is the point of the structure.
What matters is that the shape of your note is written out in full before closing. The amount, the rate, and the payment schedule should all sit in the signed documents. So should the date the balance comes due. You are then judging the actual offer in front of you rather than any general idea of how these deals usually look.
What protections does a seller note carry?
A note on its own is only a written promise to pay someone at a later date. The protections written around it are what give that promise weight if something goes wrong further down the line.
Those protections are part of the structure, and like the rest of the structure they are set deal by deal. A note can be secured against the assets of the business, so your claim is recorded in the closing documents. It can carry guarantees from the buyer. It can set out what happens if a payment is missed, including late fees and a period to put things right.
Whatever protections your deal includes, they only protect you if they are written into the documents you sign at closing. Have your own attorney read the note and the documents signed with it before you agree to anything. The cost is small compared with the amount at stake, and a note is the wrong document to take on trust.
This is general information only. It is not legal advice for your particular sale.
What are the risks of carrying a note?
Once you have sold, you are a creditor of the business rather than its owner. Creditors do not decide how a business is run and they do not control how much cash is sitting in the account on payment day.
If the buyer trades well, the note will normally be paid without much involvement from you at all. If trading turns down, the payments are often one of the first things to slip, at which point you are relying on whatever protections were put into the documents at closing.
Getting money back after a default can take a long time and you may not recover the full amount that is owed to you. That is why the size of the down payment tells you a good deal about how much risk you are really carrying on a note.
The quality of the buyer matters more in the end than a point or two on the interest rate. A buyer you trust to run the business properly at a fair rate is a better prospect than a weaker buyer who offers you a higher one.
A note also means waiting years for money you could otherwise have had in your account at closing. Only agree to finance a buyer you would be comfortable handing the business to in the first place.
If you are weighing a sale, it helps to see how selling your business works before a note is on the table.
FAQ
Is seller financing common in small business sales?
It depends on the business and the buyer. How much of the price a note covers is set deal by deal, and so is the shape of the note itself.
Can I charge interest?
Yes, and you should expect to. You are waiting for money that could have been paid to you at closing, and the interest is what you are paid for that wait and for the risk that comes with it. The rate is agreed before closing and set out in the note itself.
What if the buyer stops paying?
What you can do next depends on what was written into the closing documents. The protections agreed in those documents are what you can enforce through the courts if you need to. A note with thin protections leaves you with a claim that can be slow and expensive to pursue.
Does RockHaven ask sellers to finance?
Sometimes, where the structure of a particular deal calls for it. When we do, the amount and the terms are set out in our offer in writing, before closing.