What Is A Seller Note? (How Do Seller Notes Work?)

If you are looking to buy a business, and you want to use alternative financing methods to fund the acquisition, you might have come across the option of seller financing. Seller financing is funded by way of a seller note, but what is a seller note?

A seller note, also known as seller paper or seller debt, is when a person who is selling their business agrees to receive part (or all) of the sale proceeds over time instead of all at once. The seller gets paid in a series of debt payments after the sale closes.

What is the purpose of the seller note?

The purpose of a seller notes is to help buyers afford the purchase of businesses and avoid using bank loans. Instead of paying the full price upfront, the buyer can pay part of the price over time, and make it easier for the buyer to buy the business, and help the seller close the deal faster.

By using a seller note, or by offering seller finance, also allows the seller to potentially earn interest on the payments, so they make more money in the long run.

Some argue that seller financing or seller notes can be used to bridge the gap between total financing available to a buyer and the purchase price, which it can, but I would argue that you should begin with offering a seller note ahead of trying to arrange bank finance.

Having said that, a seller note can be used in conjunction with other forms of finance, such as asset financing and/or invoice financing too.

How does a seller note work?

Let me break down how a seller note works in simple terms:

1. Agreement: The seller and buyer first need to agree on the sale of a business and the price to be paid, or the acquisition price.
2. Funding split: The buyer then needs to calculate how the purchase price can be funded, which will hopefully be funded from the business’s future cash flows. But acquisition funding also includes agreeing with the seller what amount of the purchase price they need to be paid upfront (or the deposit at close). If the seller agrees to seller financing as part of the acquisition price, this is when a seller note needs to be created.
3. Seller note creation: Once the amount of seller financing has been agreed, the seller will give the seller a “seller note.” This is a legal document, which will include a promise by the buyer to pay the amount of seller financing over an agreed period of time.
4. Payment terms: The seller note will include details such as:
   • How much money the buyer owes (the seller finance).
   • How often the buyer will make payments (monthly, quarterly, etc.).
   • How long the buyer has to payoff the debt (the repayment period).
   • Any interest the buyer must pay in addition to the owed amount.
   • Any security the seller has over the assets of the business.
5. Payments: The buyer will then make regular payments to the seller, which are paid from the business they’ve purchased. This will be in accordance with the terms in the seller note, until the total seller finance amount (plus any interest) is paid off in full.
6. Security: Sometimes, the seller note might include terms that give the seller certain rights if the buyer fails to make payments. For example, the seller might have the right to take back the business or some other form of security.

In short, a seller note allows the buyer to pay for the business over time, helping them manage their finances, while ensuring the seller gets paid the agreed amount.

Example of a seller note:

Is a seller note equity?

A seller note is not the same as equity, as the seller note represents debt between the buyer and the seller, where as equity is the value of the shares issued by a company, which is acquired in return for the amount paid for the business, including the seller note.

Once the deal has closed, the equity passes to the buyer, which means they now own the business, but where a seller note is involved, the part of the sales price covered by the seller note is still owed to the seller.

Is a note considered debt?

A seller note is considered debt, because when a person is issued with a seller note to help fund buying a business, they are borrowing money and are agreeing to pay it back later, often with interest. This means the buyer owes the amount stated in the seller note, making it a form of debt.

So, if a seller gives a buyer a seller note, the buyer is agreeing to pay back the amount over time, which means the buyer has taken on debt.

Why are seller notes a good idea?

Seller notes are a great idea and a good way to fund the acquisition of a business, as this avoids the need for bank loans, which are slow and complicated to arrange. But also, seller notes are a great way for the seller to sell their business quickly.

Seller notes are far better than bank finance, as the note can be agreed between the seller and the buyer, without the need for complicated bank forms, delays in obtaining funding, credit checks on the business and the buyer and the unnecessary bank covenants.

The buyer and seller can start with a clean sheet and agree the seller note terms between them, so it works as a win-win for both parties.

I hope this helps you on your journey to finding a business to buy, and if you have any questions on this topic about buying a business, or on any other aspect about the process involved in buying a business, please drop a comment below.

And always remember that no question is a stupid question, if you don’t know it, you don’t know it, and by having the answer to a question you have, might be all it takes to move to the very next step in your journey to buy a business.