The short answer. It is debt on the buyer's business and a receivable to the seller. Both sides carry risk. The rate should match market for subordinated business debt (prime plus 3 to 6). Below market, the seller is subsidizing the buyer at the cost of present-value sale price. Above market, the seller captures more but at the risk the buyer defaults. The rate belongs on Layer 1 MMP of the buyer's business, grossed for taxes.
How Seller Financing Structures Work
A seller note is typically structured as a subordinated secured debt on the buyer's business. Interest is paid monthly or quarterly. Principal is paid on a schedule or as a balloon at maturity (typically 5 to 10 years).
The subordination matters. If the buyer's business also has SBA debt, the seller note is second in priority. In default, the SBA gets paid first, and the seller note may take a partial or full loss.
Interest rate on the note is negotiated between the parties. There is no fixed market. But there is a defensible range based on comparable subordinated business debt.
The Buyer's Math
From the buyer's business perspective, a seller note is Layer 1 debt service. Monthly principal payment grossed for taxes at 1.30 goes into the Debt Service sub-layer of MMP.
Layer 2 Fixed Cost Capacity picks up the interest expense from the P&L.
If the seller note is 20 to 25 percent of the total purchase price at a market rate, the impact is manageable. Layer Cake usually clears.
If the seller note is 50 to 100 percent of the purchase price (because SBA declined or the buyer had no other financing), the impact is severe. The debt service usually pushes MMP above what the pricing model can fund. That is the pattern that produces default.
The HVAC field note is exactly this. Full seller-financing of an SBA-declined deal produced Layer 1 debt service that exceeded historical peak profit.
The Seller's Math
From the seller's perspective, the seller note is a receivable. It converts a portion of the sale price into a stream of future payments rather than cash at close.
Present value matters. A $500,000 seller note at 6 percent over 7 years has a present value of roughly $415,000 to $445,000 depending on the discount rate used. If the seller is providing seller financing at below-market rates, they are subsidizing the buyer by the difference.
Risk matters. If the buyer defaults, the seller loses some or all of the receivable. In a subordinated position after SBA debt, the recovery rate on defaulted seller notes is typically 20 to 50 percent.
The correct sale price with seller financing at market rates is the same as the cash-at-close sale price adjusted for present value and risk. Sellers who lower the interest rate to make the deal work are effectively lowering the sale price without acknowledging it.
Frequently Asked Questions
What is a fair rate for a seller note?
Typically prime plus 3 to 6 for a subordinated position. Higher for smaller businesses or higher-risk transactions. Lower for larger, more established businesses. Get comparable transaction data before agreeing to a rate.
Should I ever provide seller financing at zero interest?
Almost never. Zero interest is a hidden discount on the sale price. If you want to reduce the price to help the buyer, reduce it directly. Zero-interest seller notes look generous and function as unacknowledged price cuts.
What if the buyer defaults on the seller note?
You have limited legal recourse against a subordinated position. Retain a business attorney. Prepare for the possibility that the recovery will be partial. Structure the note initially with security interests and personal guarantees where possible.
Should I sell my seller note?
The secondary market for seller notes is thin. If it exists at all for your specific note, expect a significant discount from face value. Most sellers hold the note to term. Plan cash needs around the payment schedule, not around a hypothetical sale.