Seller Notes On Full Standby: How They Cut Your Down Payment In Half

What A Seller Note Is

A seller note is a loan from the seller to you. Instead of receiving the whole price in cash at closing, the seller agrees to receive part of it later, with interest, under a promissory note. Sellers do this to close a deal, to get a better price, and because it shows they believe the business will keep performing after they leave.

In an SBA deal, a seller note can do one of two jobs:

• Count toward your Down Payment, if it is on full standby
• Fill a gap in the financing, if it is repaid alongside the SBA loan

Which job it does depends entirely on its payment terms.

What Full Standby Means

SBA's definition is strict. A note on full standby receives no payments of principal or interest for the term of the 7(a) loan. Not for the first two years. For the whole loan, which on a business purchase is usually 10 years.

A few more conditions come with it:

• The seller signs a standby agreement, SBA Form 155 or the lender's equivalent, with a copy of the note attached.
• The note can accrue interest during the standby period. That interest can be added to the balance and paid after the SBA loan is paid in full.
• The seller's note is subordinated to the lender. The seller cannot take action against you or the collateral without the lender's consent.
• The person holding the standby debt cannot also take an ownership stake in the business.

How Much Of The Down Payment It Can Cover

For a buyer purchasing a business they do not already own, SBA requires a Down Payment of at least 10% of the total project cost, and the lender cannot waive it. SBA splits the possible sources into two groups:

• Unlimited sources, like your own cash that is not borrowed, gifts and qualifying grants. These can cover all of the 10%.
• Limited sources, like a seller note on full standby, other standby debt and minority investor money. Together these can cover no more than half of the required Down Payment.

So the seller can cover up to 5% of the project on standby, and at least 5% has to come from an unlimited source. If you also bring in minority investors, their money counts against the same half. Learn about the other sources in the SBA Down Payment guide and buying a business with 5% down.

Notes That Are Not On Full Standby

Plenty of deals include a seller note that the buyer pays down over time. That is allowed. It just plays a different role:

• It does not count toward the Down Payment.
• Its payments count as debt when the lender tests your cash flow. SBA's minimum debt service coverage on a business purchase is 1.25 times all of the debt payments, including the seller's.
• If the note is interest-only for a while, the lender tests it as if it were amortizing over no more than 10 years.
• The total debt used to buy the business, SBA loan plus any seller note not on full standby, cannot exceed the business valuation.

Some deals use two notes: one on full standby to cover half the Down Payment, and a second, smaller note that is repaid alongside the SBA loan to close a gap in the price. Here are a few of the ways our clients have done it:

Real loans we placed. Borrower and lender names are kept private. See all closed deals.

Notes with a partial standby period, such as 24 or 36 months, are seller debt with a payment holiday. They can make the early years easier, but the lender still has to see that the business can carry those payments once they start.

What Happens After The SBA Loan Is Paid Off

Once the SBA loan is paid in full, the standby note starts paying. The accrued interest can be added to the balance and repaid on the schedule in the note. A note that is being paid, not on standby, can be refinanced with an SBA loan once it has been in place and current for at least 36 months after the purchase, if the new payment is meaningfully lower. A note on full standby makes no payments, so it does not meet that test while it is on standby. We cover the details in refinancing a seller note.

How To Ask The Seller For A Standby Note

Sellers often say no to full standby the first time they hear it, because 10 years is a long wait. A few things help:

1. Ask early. Put the standby note in your letter of intent so it is part of the price discussion, not a surprise in underwriting.
2. Keep it small. At 5% of the project, the standby note is usually a small slice of the price. The seller still gets around 95% in cash at closing.
3. Let the note accrue interest. The interest builds during standby, so the seller is paid for the wait. Agree on the terms with your attorney and CPA.
4. Explain why. The standby note is what makes the SBA loan possible with your cash. Without it, you may need to bring 10% yourself, or the deal may not happen.
5. Show you are a real buyer. A pre-qualification letter tells the seller and the broker that lenders have already looked at your numbers.

Seller Notes And The Rest Of The Deal

A standby note works alongside everything else in an SBA purchase. The seller can still stay on as a consultant for up to 24 months to hand the business over, though not as an owner or employee. Seller earnouts are not allowed in SBA deals, so a standby note is often the tool that bridges a gap between what the seller wants and what the valuation supports. See earnouts and SBA loans and seller financing with an SBA loan for the full picture, and the SBA business acquisition loan page for the product overview.