Seller Financing and SBA Loans: How to Structure It Right

Seller financing is a fixture in small business acquisitions. The seller carries a note for part of the purchase price, reducing the buyer’s upfront cash needs and demonstrating the seller’s confidence in the business. SBA lenders see it all the time.

But the SBA has specific, non-negotiable rules about how seller financing interacts with a 7(a) loan. Get the structure wrong, and you’ll delay your closing — or lose the deal entirely.

At GoSBA Loans, we structure seller financing alongside SBA loans every week. Here’s how to do it right under SOP 50 10 8.

Seller Financing as Equity Injection: The Standby Rules

Seller financing can count toward the buyer’s required equity injection — but only under strict conditions:

Full Standby Requirements

For seller debt to qualify as equity, it must be on full standby for the life of the SBA loan. This means:

• No payments of principal or interest during the entire term of the 7(a) loan
• Interest may accrue and be added to the standby balance
• The standby debt is amortized only after the 7(a) loan is paid in full
• The standby creditor must subordinate any lien rights in collateral to the lender’s rights
• The standby creditor must take no action against the borrower or collateral without lender’s consent

The lender must use SBA Form 155 or its equivalent, with a copy of the seller note attached.

The 50% Cap

Even on full standby, seller debt cannot exceed half of the SBA-required equity injection.

Example: Total project costs of $1,000,000 require a $100,000 equity injection (10%). Maximum seller standby debt counting as equity: $50,000. The other $50,000 must come from cash, grants, non-cash assets, or other qualifying sources.

Seller Financing Not on Standby: Subordination

Seller financing that’s not on full standby — meaning it has regular payments — doesn’t count as equity injection. But it’s still allowed in the deal structure, provided:

• It’s subordinate to the SBA 7(a) loan
• The lender analyzes the borrower’s ability to service both the SBA loan and the seller note from business cash flow
• The seller financing terms are disclosed and addressed in the lender’s credit memorandum

The Purchase Price Cap and Seller Financing

Here’s a critical rule that directly impacts seller financing structure:

The maximum 7(a) loan proceeds for any change of ownership cannot exceed the business valuation amount. When the valuation is lower than the purchase price, any financed capital required to cover the shortfall must be subordinate to the 7(a) loan.

Seller financing is the most common tool for bridging this gap. If the buyer and seller agree to a price of $900,000 but the independent valuation comes in at $800,000, the SBA loan maxes out at $800,000. The $100,000 gap is typically covered by a subordinate seller note.

Seller Earnouts: Prohibited

The SBA explicitly prohibits seller earnouts in change-of-ownership transactions. An earnout is a contingent payment where the seller receives additional compensation based on the future performance of the business.

Why? Because earnouts create an uncertain obligation that makes it impossible for the lender to properly underwrite the borrower’s debt service coverage. The total purchase price must be known and fixed at closing.

Buyer Rebates: Allowed

While seller earnouts are prohibited, buyer rebates based on business performance are allowed. The distinction:

• Earnout (prohibited): Buyer pays seller additional money if the business performs well — this increases the buyer’s total obligation
• Rebate (allowed): Seller gives buyer money back if performance exceeds targets — this benefits the borrower

If the borrower receives funds from a buyer rebate, the SBA requires that the funds first be applied to pay down the 7(a) loan to a point that won’t trigger a subsidy recoupment fee. Any remaining funds may be used for business purposes.

Refinancing Seller Notes: The 24-Month Seasoning Rule

Many buyers plan to refinance the seller note with an SBA loan after the business stabilizes. The SBA allows this — but with conditions:

• The seller-financed note must have been in place and current (not on standby) for at least 24 months following the change of ownership
• The refinancing request must meet the SBA’s 10% improvement to installment payment amount requirement
• If the change of ownership was between existing owners and existing business debt will be refinanced as part of the transaction, the standard refinancing requirements apply

Key Implications

• If the seller note is on full standby (no payments), the 24-month clock doesn’t start until it comes off standby and begins making current payments
• The note must have been current for the full 24 months — meaning no missed or late payments
• The refinancing must demonstrate a 10% or greater reduction in the borrower’s installment payment

This means if you have a standby seller note as part of your initial acquisition, you can’t immediately refinance it with a new SBA loan. The SBA wants to see the business carry the debt normally for two years first.

Paying Off Seller Debt in a Change of Ownership: Not a Refinance

Important distinction: paying off debt as part of a change of ownership is not a refinance. In a complete change of ownership, the option to assume existing SBA debt should be offered to the buyer, but paying off the seller’s loans from the buyer’s loan proceeds is considered part of the acquisition — not debt refinancing.

This matters because refinancing rules (like the 24-month seasoning and 10% improvement test) don’t apply when you’re simply paying off the seller’s debt as part of the purchase transaction.

How Lenders Evaluate Seller Financing

The lender’s credit memorandum must address seller financing specifically:

• Terms and conditions of the seller note
• Whether the note is on standby or amortizing
• How the borrower will service both the SBA loan and seller note
• Subordination terms and documentation
• Impact on the borrower’s debt service coverage ratio

The SBA requires that the borrower’s operating cash flow divided by total debt service (including any seller financing not on standby) be at least 1.15:1 within 2 years of funding.

Structuring Seller Financing: Best Practices

Scenario 1: Seller Note as Part of Equity Injection

Buyer needs $100K equity injection. Structure: $50K cash + $50K seller standby note (no payments, full life of SBA loan). Total: $100K qualifying equity.

Scenario 2: Seller Note to Bridge Valuation Gap

Purchase price $900K, valuation $800K. SBA loan covers $800K. Seller carries $100K subordinate note with payments from business cash flow. Lender must underwrite both obligations.

Scenario 3: Seller Note for Working Capital Buffer

Purchase price $600K fully financed by SBA loan. Seller provides separate $50K subordinate note to fund working capital post-closing. Must be subordinate, must be included in debt service analysis.

Common Seller Financing Mistakes

1. Agreeing to an earnout: Prohibited. Structure performance-based adjustments as buyer rebates instead.
2. Assuming standby seller debt covers the full equity injection: It can only cover half. The rest must come from other sources.
3. Putting the seller note on standby without proper documentation: Must use SBA Form 155 or equivalent with the note attached.
4. Planning to refinance the seller note too soon: 24-month seasoning (current payments, not standby) is required.
5. Failing to subordinate: Any seller financing must be subordinate to the SBA loan. Seller liens on collateral must be subordinated to lender’s rights.
6. Not disclosing seller financing: All seller financing must be disclosed and analyzed in the credit memorandum. Undisclosed seller notes can result in SBA denying the guaranty.

Seller Financing in 504 Projects

For 504 loan projects involving a change of ownership, any financing provided by the seller must be subordinate to the 504 loan and may not be prepaid without SBA consent. The seller generally may not remain as an officer, director, stockholder, or Key Employee under 504 rules.

The Bottom Line

Seller financing is a powerful tool in SBA acquisitions — but it must be structured within the SBA’s rules from day one. Standby requirements, the 50% equity cap, earnout prohibition, and 24-month seasoning rules aren’t suggestions. They’re requirements that lenders and SBA will enforce.

Structuring a deal with seller financing and an SBA loan? Contact GoSBA Loans — we’ll make sure the seller note structure works for both parties and meets every SBA requirement.