SBA-friendly LOI language for seller note in lieu of "escrow"?

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September 25, 2023

by a searcher from Harvard University - Harvard Business School in Westchester County, NY, USA

I understand SBA says escrows are SBA ineligible.

Can you get the same result an escrow would provide, collateral against a violations of reps & warranties, etc. built into a seller note?

Does anybody have any LOI language that can make that happen?

Thank you!

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Reply by a searcher
from University of California, Los Angeles in Tampa, FL, USA
Hi there - I think what you're describing is just a Seller Note that can be offset with post-closing indemnity claims.

I know the SBA doesn't allow for earn-outs, but I'm not aware of any limitation against offsets to a Seller Note for indemnity claims (claim for breaches under reps / warranties). In fact, I know that forgivable Seller Notes are common in SBA financed deals, which involves "forgiveness" of the Note when the company doesn't meet certain historical performance metrics.

I don't think there is anything that keeps you from having a Seller Note that acts like an indemnity escrow as long as the agreement doesn't work like an earnout. Some of the SBA lenders on Searchfunder can correct me here if I'm wrong.

As far as LOI language, I think you can keep the concept fairly simple. You'll obviously want to cover your right to indemnify for claims relating to breaches of reps / warranties, but then you can add something along the lines of: "The Buyer may offset claims for indemnification against any payments that it owes on the Seller Note."
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Reply by a professional
from University of Denver in Denver, CO, USA
Yes, you can have seller note offset language in your purchase agreement. It is typically a paragraph in the agreement that says that you can offset the amount owed under the seller note for any breaches of representations, warranties or covenants of the seller. Sometimes there is language that says you can only offset after the loss has been agreed to or determined by a court of competent jurisdiction. The only issue I've seen with seller note offset language is when you're using the seller note as part of the buyer equity injection because it is on full standby. I've had banks argue that there can be no offset to that note during the life of the bank loan because it is being credited toward equity and must remain outstanding. That never made any business sense to me, but nevertheless we had to create to seller notes in that transaction with one on full standby (and credited toward equity for SBA purposes) and one subject to an offset.
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