Most ETA operators walk into their first LOI thinking the SBA 7(a) loan is the primary variable. It is not. According to the 2023 SIG Self-Funded Search Study, 45% of self-funded search acquisitions included a seller note. Almost half of all deals involve the seller staying financially committed to the outcome. That number tells you everything about where the real negotiation happens.
What seller financing actually is
A seller note is a loan from the seller to the buyer. Instead of collecting the full purchase price at closing, the seller accepts a portion as a promissory note. The buyer makes regular payments over a defined term, with interest. The note sits below senior debt in the capital structure. If the business defaults, the bank collects first.
In plain terms: the seller is betting that you will not blow up their business. That alignment of interests is worth more than the interest rate.
The 2023 SIG study breaks down the mechanics. Of acquisitions that included a seller note, 61% sized it at 10% to 20% of the purchase price. Seventy-nine percent carried interest rates between 4.0% and 7.9%. Forty-four percent had a five-year term. These are not outliers. They are the standard.
Why sellers say yes
Three factors drive seller willingness to carry a note: taxes, deal certainty, and price.
Tax deferral. IRC Section 453 allows sellers to use the installment sale method. Instead of recognizing the full capital gain in year one, the seller recognizes gain as principal payments arrive. A business owner who built $3 million in equity over 20 years faces a significant tax event at the moment of sale. Spreading that gain over five years can mean the difference between a top bracket hit and a manageable tax load. According to Baton Market's analysis of seller financing tax implications, this benefit alone often justifies a seller accepting below-market terms on the note.
Deal certainty. Seller financing expands the buyer pool. More buyers creates more competition. More competition drives a higher headline price. Sellers who want maximum exit value use seller notes as a strategic tool to attract buyers who could not otherwise finance a full acquisition. The seller loses nothing on the interest rate and gains a better bid.
Transition alignment. A seller who holds a note is financially motivated to support the handoff. That motivation is worth real money in the 90 days after closing when nothing goes according to plan. The seller's ongoing financial interest creates an incentive to answer the phone.
The capital stack in practice
The 2024 Stanford GSB Search Fund Study puts median purchase price for traditional search fund acquisitions at $14.4 million, down from $16.5 million the prior year as higher interest rates compressed multiples. Median EBITDA at acquisition: $2.2 million. Median EBITDA multiple: 7.0x. Seller notes in traditional search fund deals typically represent 10% to 25% of acquisition capital.
At $14.4 million with a 15% seller note, the seller is holding $2.16 million in subordinated debt. That is a significant bet. Structure it accordingly.
The classic SBA-backed self-funded deal runs an 80/10/10 structure:
- SBA 7(a) senior debt: 80% of purchase price
- Seller note (on standby): 10%
- Buyer cash equity injection: 10%
On a $2 million acquisition, that is $1.6 million in SBA debt, a $200,000 seller note, and $200,000 from the buyer's own funds. Clean. Simple. Most lenders understand this structure without explanation.
In a traditional investor-backed search fund deal at $10 million, the structure looks different:
- Senior bank debt: $5 million to $6 million (50% to 60%)
- Seller note: $1 million to $2 million (10% to 20%)
- Investor equity plus searcher equity: $2 million to $3 million (20% to 30%)
The investor-backed deal is not constrained by SBA rules. Regular payment schedules over three to seven years are standard. No standby requirements. Monthly or quarterly payments begin shortly after closing. The seller gets cash flow from the note rather than waiting a decade.
For context on the broader lower-middle-market acquisition framework, see the PGC guide to lower-middle-market private equity.
The SBA standby rule: updated June 2025
If you are using SBA 7(a) financing, this rule matters. The SBA revised its Standard Operating Procedures (SOP 50 10 8), effective June 1, 2025, reinstating the full standby requirement for seller notes used as the equity injection.
Here is what the rule requires. The SBA mandates a 10% equity injection on business acquisitions. A seller note can satisfy up to 5% of the purchase price toward that requirement. But only if the note is placed on full standby for the entire SBA loan term, typically 10 years.
Full standby means zero principal payments and zero interest payments until the SBA loan is paid off. Not partial standby. Not deferred interest with a catch-up. No payments at all.
If the seller note is not on full standby, the SBA treats it as additional debt, not equity. That worsens the buyer's debt service coverage ratio (DSCR) calculation and can sink the loan approval.
For a $2 million deal, a buyer who wants the seller note to count toward the equity injection must convince the seller to accept zero payments for up to 10 years. That is a hard ask. Some sellers accept it; many do not. Know the constraint before you structure the LOI. According to Pioneer Capital Advisory's breakdown of SBA seller financing rules, the 2025 change reverses the briefly more lenient 2023 to 2025 window when partial standby notes could partially count toward equity. That window is closed.
Two risks buyers skip
Two provisions get buried in the excitement of deal closing. Both can kill you.
Acceleration clauses. Most seller notes include a provision that accelerates the full remaining balance if you miss a payment, breach a covenant, or sell the business before the note is paid off. A due-on-sale clause means adding equity partners or selling within the note term triggers an immediate demand for full repayment. These clauses are negotiable before signing. Most buyers do not negotiate them because they are not looking for them. Read the promissory note. Hire M&A counsel who reads promissory notes for a living.
Personal guarantees. Sellers routinely require a personal guarantee on the note. Combined with the personal guarantee that SBA 7(a) loans require, a buyer in a failed acquisition faces simultaneous claims from two creditors against personal assets. That is not a theoretical risk. It is the lived experience of operators who over-leveraged into a business that did not perform.
The practical test is this: total annual debt service on the SBA loan plus the seller note should not exceed 60% to 70% of the seller's discretionary earnings (SDE) at closing. If the business cannot clear that threshold under the deal structure you are proposing, the structure is too aggressive for the fundamentals.
Negotiating the note
Most first-time buyers accept standard seller note terms because they are relieved the deal is still alive. That is the wrong posture.
The interest rate is negotiable. A seller who is highly motivated to close will accept 5%. A seller with multiple buyers competing will hold at 8%. Know which situation you are in before you sit down.
The standby period is negotiable. If you are not using SBA financing, there is no regulatory floor. Push for no standby, or a short six-month deferral on principal while you stabilize operations.
The acceleration clause is negotiable. A seller who is confident in your ability to run the business does not need a hair-trigger acceleration provision. Propose a cure period of 30 to 60 days before acceleration kicks in. Most sellers will accept it.
The personal guarantee scope is negotiable. A spousal carve-out, a guarantee limited to the note balance rather than the full business debt, or a sunset provision that reduces the guarantee as the note amortizes. All of these are standard M&A negotiations. Few first-time buyers know to ask.
The operator's read
Seller financing is not optional in most ETA deals below $5 million. It is structural. The SIG study's 45% figure underrepresents true prevalence because many sellers informally finance transitions through consulting agreements, extended earnouts, and deferred compensation that do not show up as formal seller notes in the data.
The operator who closes a good deal is not the one who found the best business. It is the one who read the promissory note before signing it, understood what the standby requirement actually meant for their SBA approval, and negotiated the acceleration clause when the seller still needed them to close.
The capital stack is not a formality. It is the financial architecture that determines whether you survive the first year of ownership.
PGC works with veteran operators at every stage of the acquisition process. The capital structure conversation starts before the LOI, not after. If you are evaluating your first acquisition, start the conversation here.
