How To Refinance A Seller Note With An SBA Loan

Why Buyers Refinance A Seller Note

Seller notes are usually shorter than the SBA loan they sit next to. A note repaid over three to five years can carry a large monthly payment, and many buyers feel it most in the years right after closing. Some notes end in a balloon payment. And some sellers simply want to be paid off so they can move on.

Refinancing replaces the seller note with a new loan on longer terms, which lowers the payment and frees up cash. It also ends the financial tie to the seller, which some buyers and sellers both welcome once the transition is done. The seller financing guide explains how these notes are set up in the first place.

The SBA Rule: 36 Months, Current And Not On Standby

SBA allows seller debt that was part of a change of ownership to be refinanced, but not right away. In its change of ownership rules, SBA says a seller-financed note must have been in place and current, with the words "not on standby," for at least 36 months following the change of ownership. The refinance must also pass SBA's 10% payment improvement test and must not reduce the lender's exposure.

In plain terms:

• 36 months of history after closing
• Current means no payment has gone unpaid for more than 29 days
• Not on standby means the note has been paying, not sitting on a payment holiday

If your note started with a partial standby, say no payments for the first 24 months, ask your lender early how it counts those months. Most lenders read the rule conservatively, so plan on a full 36 months of on-time payments.

The 10% Payment Improvement Test

When an SBA loan refinances debt, the new payment has to be at least 10% lower than the payments it replaces. If you refinance other business debt at the same time, the payments can be added together for the test.

SBA's rules list some exceptions to the 10% test, including debt with a balloon payment or a demand note. If your seller note ends in a balloon, ask your lender whether the exception applies to your note.

For debt that financed goodwill and other intangibles, SBA limits the term to 10 years, and the term must be the shortest appropriate for the use and your ability to repay. The longer term is usually what produces the lower payment. The SBA acquisition loan terms guide covers how terms are set.

What A Full Standby Note Means

A note on full standby is a different animal. If a seller note counted toward your Down Payment, it was on full standby: no payments of principal or interest for the entire term of the SBA loan, under a standby agreement with your lender. That note is not current and paying, so it does not meet the "not on standby" test, and paying it off early would break the standby agreement you signed.

In practice, a full standby note is repaid after the SBA loan is paid off, with any accrued interest, on the schedule in the note. The standby note guide explains why that trade made your Down Payment work.

Many deals have both kinds: a standby note that covers half the Down Payment and a second note that is paid alongside the SBA loan. The second note is the one that may become a refinance candidate. Here are a few deals that closed with a note repaid alongside the SBA loan:

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

What The Lender Will Need

Any SBA refinance comes with a written analysis by the lender. It covers why the debt was taken on, why refinancing will not pay off a creditor who is about to take a loss, why the debt is being restructured, and how the new loan improves the business's finances. Expect to provide:

1. A copy of the seller note and any security agreement
2. A payment history showing every payment for the last 36 months, with dates
3. A current payoff statement from the seller
4. Business tax returns and current financial statements, so the lender can underwrite the new loan on cash flow
5. Details of any other debt being refinanced at the same time

The lender itemizes in the loan terms each creditor being paid $10,000 or more, so the seller will appear by name. And the business's existing SBA loan must be current too; SBA will not issue a new loan number if an existing 7(a) or 504 loan is more than 29 days past due.

Ways To Structure It

There are a few common paths, and the right one depends on your current lender and your balances:

• A new SBA loan from your current lender that pays off the seller note, while the original acquisition loan stays in place.
• A new lender that refinances both the original SBA loan and the seller note into one loan. SBA allows a lender to refinance another lender's 7(a) loan if the refinance rules are met. Your current lender can refinance its own 7(a) loan only in narrow cases, so this path usually means a new lender.
• A conventional loan for the seller note, if a bank is willing and the terms are better.
• An early payoff discount. Some sellers will accept less than the full balance for cash now. That is a negotiation, not an SBA rule.

SBA's loan limits apply to your business and its affiliates as if they were one business, so your existing SBA balance counts toward the limit. Our debt refinancing page covers refinancing more broadly.

Plan For The Refinance At Closing

The easiest refinance is one you planned for in the letter of intent. When you negotiate the seller note, ask your attorney to make sure it can be prepaid at any time without a penalty, and that the seller has to provide a payoff statement when asked. Keep a clean payment record from month one, and pay by bank transfer so the history is easy to prove. The first 100 days guide covers the other habits that make month 36 easier.

If you are still structuring a purchase, a pre-qualification letter shows the seller note terms lenders will accept, and the SBA business acquisition loan page explains the loan itself.