A buyer came to us with a deal that was nearly done. Good business, $900,000 price tag. The bank was happy to lend against the equipment and the stock, but not the goodwill, and goodwill was most of the price. The buyer had $300,000 in cash. That left a gap of $250,000.
The seller offered to fill it himself. He would take $250,000 of the price over three years, paid out of the business the buyer was about to run. The buyer asked us whether that was normal. It is. It’s called vendor finance, and the document that records it is usually called a seller note.
This post covers what a seller note is, why sellers agree to them, and the terms that decide who carries the risk if the business doesn’t perform.
What a seller note is
A seller note is a loan from the seller to the buyer for part of the purchase price. The buyer pays some of the price at completion and owes the rest. The debt is documented either in the sale agreement itself or in a separate loan agreement.
It is not an earnout. An earnout is extra price that the buyer only pays if the business hits agreed targets after completion. A seller note is a fixed debt. The buyer owes it whether the business hits its targets or not. Some deals use both. Keep the two apart in your head, because they allocate risk in opposite directions.
Why sellers agree
Sellers do not offer finance out of generosity. They offer it because it gets the deal done.
Banks are cautious about lending against goodwill. In a service business, a consultancy, a trades business or an online store, goodwill can be most of the value. That leaves many buyers unable to borrow the full price. A seller who will not take part of the price on terms may not find a buyer at that price at all.
Vendor finance also bridges a gap in confidence. A seller who says the business earns $400,000 a year, and who is prepared to be paid out of those earnings over three years, is backing that claim with their own money. Buyers read that signal and often pay more for it.
For the seller the trade-off is real. They give up part of the price today and take a credit risk on the buyer and the business. Everything in the note is about managing that risk. The buyer’s job is to make sure the risk stays where it belongs.
The terms that matter:
Amount, term and repayment
How much is deferred, over how long, and in what instalments. Monthly instalments over three years is common. A balloon payment at the end is also common and is much harder on the buyer’s cash flow. The buyer should model the repayments against the business’s actual cash flow, after their own salary and after the bank loan, before agreeing to a schedule.
Interest
Seller notes usually carry interest. Sometimes the rate is below what a bank would charge, because the seller wants the deal done. Sometimes it is above, because the seller is taking risk a bank would not. Whatever the rate, check whether interest is charged on the full balance from completion or only on the outstanding balance as it reduces, and what happens to the rate if the buyer defaults.
Security
This is where the risk is really allocated.
A seller will usually ask for security. In an asset sale that means a general security agreement over the business assets, registered on the Personal Property Securities Register. In a share sale it may mean a charge over the shares the buyer has just bought, so that if the buyer defaults the seller can take the company back. Sellers also commonly ask for a personal guarantee from the buyer or from the buyer’s directors.
The buyer should think carefully about each layer. A personal guarantee means the buyer’s house may be exposed if the business fails. A charge over the shares means a default can hand the whole business back to the seller, even if the buyer has paid most of the price. These outcomes are not unreasonable from the seller’s side. They should be priced and understood from the buyer’s side.
Priority against the bank
If the buyer also has a bank loan, the bank will insist on ranking first. The seller’s security will be behind the bank’s. This is usually recorded in a deed of priority or a subordination deed, and the bank will often require the seller to agree not to enforce their security without the bank’s consent.
Sellers sometimes do not appreciate what this means until it is put in front of them. Behind a bank, a seller note is closer to equity than to debt. If the business fails, the bank is paid first and the seller may get nothing. That is a fair reason for a seller to ask for a higher rate or a shorter term. It is not a reason to pretend the note ranks higher than it does.
Default
The note will list events of default. Missing a payment is the obvious one. Others usually include the buyer becoming insolvent, breaching the bank loan, or selling major assets. On default, the seller can usually demand the whole balance immediately and enforce their security.
Buyers should look for two things. A cure period, so that a late payment can be fixed before it becomes a default. And a clear list, so that the seller cannot call a default on something vague.
Set-off
This is the term buyers most often miss and sellers most often resist.
A buyer who discovers after completion that the seller breached a warranty, say by overstating revenue or hiding a dispute, has a claim against the seller. If the buyer still owes the seller money under the note, the sensible thing is to deduct the claim from the next instalment. That is a right of set-off.
Sellers will try to exclude it. They will say the note must be paid in full regardless of any claim, and the buyer can sue separately. From the buyer’s side, a right of set-off is often the only practical way to recover a warranty claim without litigation. It should be negotiated, not conceded.
Covenants while the note is outstanding
A seller who is owed $250,000 by a business they no longer control will want some visibility. The note may require the buyer to provide financial statements, keep insurance in place, not pay dividends above a threshold, and not sell the business or its major assets without consent. These are ordinary. The buyer should make sure they can live with them for the whole term.
What happens if the business is sold before maturity
Buyers do not always hold for three years. If the buyer sells the business, or sells the company, before the note is paid, the seller will want the note repaid in full from the sale proceeds. That is usually a mandatory prepayment on change of control. Without that term, a buyer could sell to a stranger and leave the original seller’s debt sitting with a company they have never met. Sellers should insist on this term. Buyers should expect it and make sure any early repayment carries no penalty.
Who carries the risk
Put it all together and the picture is this.
The seller carries the risk that the business does not perform and the buyer cannot pay. Security, guarantees and covenants reduce that risk but do not remove it, especially behind a bank.
The buyer carries the risk that the business does not perform and they lose it anyway, along with whatever they have personally guaranteed. A well drafted note gives the buyer cure periods, a right of set-off, and a realistic repayment schedule. A badly drafted one can turn a bad year into a lost business.
Before you sign
Whether you are the buyer or the seller, get the note reviewed before it is signed, not after. Registration on the PPSR has a time limit and getting it wrong can cost the seller their security if the buyer becomes insolvent. Set-off, priority and prepayment terms are cheap to negotiate at the start and expensive to argue about later.
If you are buying or selling a business and vendor finance is part of the deal, we can scope the work and give you a fixed quote within 48 hours, with no obligation.
