A quick note:

Make sure to check out my business SMB Business Plans if you're in need of a business plan for your SMB acquisition. We know how to write these business plans in the exact style that SBA lenders are looking for.

Also, check out Pioneer Tribe Insurance if you need insurance around your business acquisition.

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If you're buying a business, you love seller financing.

It's flexible and can help close a funding gap that otherwise wouldn't be filled.

But, you must understand the SBA rules regarding seller financing.

There are certain ways your seller financing must be structured, especially when used as part of the buyer's equity injection, that you must follow in order to qualify for an SBA loan.

Let's dive into it with an example.

Let's say Jane is buying an engineering company in Orlando, Florida, and is considering several different seller note structures.

Key SBA Requirement: Subordination Agreement

All seller notes, regardless of their purpose, must comply with the SBA’s subordination requirement.

Basically, the SBA loan retains repayment priority over the seller note.

To formalize this, sellers are required to sign an SBA Form 155 – Standby Creditor Agreement, acknowledging the subordination and any payment restrictions tied to their note.
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Two Types of Seller Notes in SBA Financing

The SBA distinguishes between seller notes used as part of the buyer’s equity injection and those that are not.

Seller notes tied to the down payment must meet stricter requirements, while notes outside the down payment offer greater flexibility.

When a seller note is applied toward the buyer’s down payment, it must either be on:

• Full standby for the duration of the SBA loan, meaning no payments can be made until the SBA loan is paid off, or
• on partial standby, where payments are deferred for at least two years after closing before resuming on an amortization schedule.

These restrictions exist to protect the SBA loan’s priority and ensure the business has adequate cash flow during the critical early years after the acquisition.

Matthias Smith, CEO - Pioneer Capital Advisory LLC @SBA_Matthias A seller note on full standby "incentivizes the owner to help you for the life of the loan and helps create a higher cash on cash return for you as an entrepreneur" - Fady Ebeid, a searcher that worked with Pioneer Capital Advisory LLC #sba #smb #acquisitions #entrepreneurs 7:9 PM • Dec 9, 2022 20 Retweets 91 Likes Read 11 replies

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Seller notes not used toward the down payment allow for greater flexibility.

Payments on these notes can begin immediately after closing, provided the seller agrees to subordinate their repayment to the SBA loan.

Many buyers use this flexibility to structure creative solutions, such as a 10-year amortization schedule with a balloon payment due in year four, or by incorporating performance-based forgivability mechanisms.

In the latter case, if the business’s financial performance falls below an agreed threshold after closing, the seller note payments may be reduced or even eliminated, providing additional protection for the buyer.

This is a great structure to use if there's uncertainty about the business' performance after the old owner steps away.
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Case Study: Jane’s Acquisition of an Engineering Company

Jane, a seasoned project manager, acquired an engineering firm in Orlando, Florida, for $2 million. The deal included:

• $1.5 million in SBA financing
• $200,000 in buyer cash
• $300,000 in seller notes, split between a note applied toward the down payment and one that was not.

For the seller note applied toward the down payment, Jane negotiated partial standby terms, deferring payments for the first two years and resuming them on a 10-year amortization schedule starting in year three.

This structure reduced Jane’s upfront cash requirements and ensured compliance with SBA rules, while giving the seller confidence in the business’s ability to generate sufficient cash flow for repayment.

The second seller note, not tied to the down payment, was structured with a 10-year amortization schedule and a balloon payment at the end of year four.

Jane also incorporated a forgivability clause into this note, allowing payments to be paused or reduced if the company’s EBITDA fell below $450,000 within the first three years.

This flexible arrangement gave Jane financial breathing room during the ownership transition while aligning the seller’s interests with the ongoing performance of the business.

Key Takeaways from Jane’s Deal

Jane’s strategic use of seller notes illustrates the importance of understanding SBA requirements and leveraging the flexibility available with non-down payment notes.

With smart structures, Jane minimized her personal cash injection, preserved cash flow, and aligned the seller’s incentives with the long-term success of the business.

Seller financing, when structured thoughtfully, can be one of the most powerful tools in SBA-financed acquisitions. Just make sure the terms you and the seller agree to align with the SBA requirements!

Disclaimer: The information in this newsletter is for informational purposes only and should not be considered legal or financial advice. Business buyers are encouraged to consult with their legal counsel and accountant to ensure the proper structuring of their transactions and to fully understand the tax implications of seller financing.

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