Seller Financing is one of the most significant source of funds that a searcher uses to finance their purchase. It demonstrates the seller’s confidence in the future of the business under new leadership, and gives the searcher a way to bridge the gap between bank and equity financing. Taking a secondary position to the bank, it provides comfort to the debt lender for any downside scenarios. Seller financing can be more complex than bank financing, so it pays to fully understand, and leverage, the options available to the astute searcher.

Price is rarely the only factor in the seller’s mind. They are also concerned about when they will receive the cash for their business. Sellers are often willing to wait for their money, to receive the full value they feel the business is worth, while collecting attractive interest payments along the way. Convincing a business owner who may want “all cash” to be willing to take a promissory note and defer payment is one of the more challenging and critical aspects of the negotiations with a seller.

Terms and Conditions of Seller Loans

Surveying about two dozen search transactions showed only two without seller financing, one of them a “carve-out” from a larger organization and the other a lower multiple, all-cash transaction. Seller-financed amounts averaged 22% of the transaction value, with a median of 25%, a low of 2% and a high of 40%. Loan sizes were as low as $175K and as high as $10MM, with the average at $1.7M.

Term length averaged 5.3 years with a high of 10 years and a low of 3. Up to 70% of transactions carried a balloon payment, and many employed a variety of creative parameters including interest-only for the entire term, interest/principal-free for the first two years, amortization of 1.5 to 2x beyond the term length and a few “back-weighted” principal payments. SBA backed loans required a seller “standby” for 2 years with no interest or principal payments.

Interest rates were generally only 1% higher than the bank financing associated with the transaction, perhaps the result of low interest rates on bank savings and US Treasuries. The average was 5.68% with a low of 4% and a high of 8%. A few were pegged to the prime rate, with the majority a simple fixed amount, and 80% at whole numbers! 10% reported purchasing life insurance on the searcher. 50% demanded a Personal Guarantee from self-funded searchers and one carried a stock pledge.
All notes were subordinated to the bank financing (see Blog Post – Bank Financing). Numerous searchers echoed the advice of Zack Belzberg at Northmont, “Make sure the seller fully understands their subordination to the bank from very early on in the process, pointing out that it is senior to equity and the searcher.” Attributing the subordination to the bank’s requirements takes you out of the hot-seat on this sensitive issue. Ben Murray of New Forest says “Sellers will react badly if surprised when you ask them to sign the subordination agreement.” A final note from one searcher, “Get the seller’s adviser and/or family lawyer to OK the terms early. Even after your seller agrees to the terms, his/her adviser can still reopen the negotiation.”

A few searchers reported contingencies which tied the seller to performance measurements. In one case with high customer concentrations, overall revenue targets were specified and ongoing seller engagement stipulated. In another, specific revenue targets of critical customers were required. One searcher added a note of caution when multiple sellers are involved – “You want the largest selling shareholder (hopefully the owner / operator) to take the entirety of the note – don’t split it!” Finally, don’t forget to discuss early repayment options on the seller note with the bank before making any commitments to the business owner.

Narrative surrounding seller financing

Your ability to secure bank financing and equity investment will likely be predicated on your attaining a seller note, as some lenders may insist that a portion of the sale be financed by the seller. Educate the seller during your initial conversations about how you plan to finance the purchase of their business. Reluctance by searchers to bring this up early are natural and based on the fear of losing a “prospect”. Your delay will be quickly exposed by the IOI (See Blog Post – Making IOI’s and LOI’s) term sheet, which spells out these details, risking a catastrophic erosion of trust. Better to get it on the table quickly, as just one of the many variables in the transaction, as Tyler Hogan from East Range says, “Figure out what the seller cares about most. Work quickly toward a middle ground.”

A recent survey by BizBuySell reports that 58% of owners and 74% of brokers believe a seller carryback to be either essential or important to closing small business acquisitions. Further, 41% of seller’s rate having a “good buyer fit” as their top priority in a sale. There are some industries, like insurance or where customer concentration is high, where seller notes are the only way to complete a transaction.

In your presentation to the seller, you will want to reinforce their belief that the company you are buying has a bright future. A promissory note supports a shared vision of business growth and stability, backed up by the seller’s financial commitment and their engagement in the business beyond closing. The result, in this narrative, is a win-win that makes the business easier to purchase, while protecting the seller’s legacy. Further, conventional wisdom holds that sellers who have an ongoing stake are less likely to compete with the business they have sold. They may know that bank financing is available to the searcher, but may want to participate in receiving interest payments from you.

In negotiations with the seller, it is best to start with a mid-range percentage for the seller note, leaving room for concessions over multiple rounds of negotiations around all deal terms. If there is pricing pressure, the seller note percentage can be increased. With interest rate, term length and payment holidays, it is best to lead off with more buyer-friendly terms and prepare to horse trade. A balloon payment and relief during the first few years on interest/principal payments may help reduce the cash flow burden. Reggie Stevens at Crescent Peak suggests, “Discuss these terms in detail early (pre-LOI); don’t be afraid to over-educate the seller. There are a lot more moving parts in this area than a focus on the total price.”

Taxes are often in the forefront of the seller’s mind. Payment of principal on seller notes can be considered as “installment sales”, whereby the capital gains taxes are delayed until the note principal is paid to the seller, which will appeal to the seller’s tax advisor. Also, seller payments can be associated with a non-compete agreement, with a back-weighted payment schedule, which are deductible for tax purposes for both seller and searcher.

Other Considerations

Drawing a distinction between the seller note and escrow hold-back is important. The seller will want to hear that the searcher is committed to the obligation to pay, and not as an “adjustment” account to resolve financial issues that come up after closing. The escrow, which may range from 5-15%, is designed to fund any inaccuracies in data, unrevealed costs or issues that the owner potentially did not disclose to the buyer and are discovered after closing. Again, address this early with the seller, who should not be surprised by an escrow at closing. As one searcher pointed out, “not having to pay a note is not the same as getting cash from an escrow to cure a deficiency on the purchase; the seller is going to want to feel your full commitment to their promissory note.”

A seller earn-out, commonly used by PE firms, is problematic for a searcher and is too often used to meet a seller’s price expectation. In practice, searchers who have used this technique more often end up with disputes with ex-owners over accounting practices post-closing. Sellers may additionally seek a board position, always a dangerous precedent for an inexperienced searcher/CEO to face both investors and the prior owner at the board table. As Ari Medoff of Arosa says, “Avoid having the seller retain equity. Most want to put the business behind them and may struggle with the transition and be very vocal about it.”


While the seller’s participation in financing the sale may represent a smaller amount of the total debt, it includes numerous negotiated terms and issues that are financially and emotionally important to the seller. Get to these points early in your discussions and work hard to educate the seller with the narrative of why an “all cash” sale is neither feasible nor advisable for search transactions.

Many of these elements will be new to the business owner who is considering selling their business for the first time. As your experience with search progresses, this significant dialog with the seller will become easier, as you assess their needs and concerns and craft the “narrative” around the seller financing.

Search on!

Feel free to share some of your own best practices or experiences in dealing with these issues in the blog comments. I encourage comments and dialog, allowing all to learn from both my views and the views of others – a virtuous learning cycle. Jump right in! I frequently update individual blog posts, add to the Reference section and Search tips, so visit the website regularly.