Transaction Academy · Module 15
Promissory Notes & Seller Financing.
Not every business acquisition is financed entirely with cash at closing. Learn how seller financing works, how promissory notes structure repayment obligations, and what buyers and sellers negotiate when part of the purchase price is paid over time.
Overview
Not every business acquisition is financed entirely with cash at closing. In many lower middle-market transactions, the seller agrees to finance a portion of the purchase price, allowing the buyer to pay over time.
Seller financing can help bridge valuation gaps, expand the pool of qualified buyers, and demonstrate the seller's confidence in the business. At the same time, it introduces additional legal and financial considerations for both parties.
The principal document governing seller financing is the Promissory Note, which sets forth the buyer's obligation to repay the financed portion of the purchase price according to agreed terms.
This course explains how seller financing works, the role of promissory notes, and the key provisions commonly negotiated in acquisition transactions.
Lesson 1
What Is Seller Financing?
Seller financing occurs when the seller agrees to accept payment of a portion of the purchase price over time rather than receiving the full amount at closing.
Instead of borrowing all acquisition funds from a bank, the buyer owes part of the purchase price directly to the seller.
For example:
- Purchase Price: $5,000,000
- Cash at Closing: $4,000,000
- Seller Financing: $1,000,000
The buyer signs a Promissory Note agreeing to repay the financed amount according to negotiated terms.
Lesson 2
Why Use Seller Financing?
Seller financing can benefit both buyers and sellers.
For Buyers
Seller financing may:
- Reduce the amount of cash needed at closing.
- Help complete transactions where traditional financing is limited.
- Demonstrate the seller's confidence in the business.
- Improve liquidity after closing.
For Sellers
Seller financing may:
- Increase the number of qualified buyers.
- Facilitate a higher purchase price.
- Generate interest income.
- Help complete transactions that might not otherwise close.
Like any financing arrangement, seller financing also introduces additional risks that should be carefully evaluated.
Lesson 3
What Is a Promissory Note?
A Promissory Note is the legal document evidencing the buyer's promise to repay the seller.
The note generally specifies:
- Principal amount
- Interest rate
- Payment schedule
- Maturity date
- Default provisions
- Prepayment rights
- Applicable law
The Promissory Note is often executed simultaneously with the purchase agreement and becomes effective at closing.
Lesson 4
Secured vs. Unsecured Notes
Not all seller notes provide the same level of protection.
Secured Promissory Note
A secured note is backed by collateral.
Collateral may include:
- Business assets
- Equipment
- Inventory
- Accounts receivable
- Ownership interests
- Other pledged property
If the buyer defaults, the seller may have contractual rights against the collateral, subject to the terms of the applicable agreements and governing law.
Unsecured Promissory Note
An unsecured note is not backed by specific collateral.
Instead, the seller generally relies on the buyer's contractual obligation to repay.
Because unsecured notes typically present greater credit risk, the parties may negotiate other protections.
Lesson 5
Payment Structures
Promissory Notes can be structured in many different ways.
Common payment arrangements include:
- Fully Amortizing Payments — Each payment includes principal and interest until the note is fully paid.
- Interest-Only Payments — The buyer pays only interest during the term, with the principal due at maturity.
- Balloon Payment — Smaller periodic payments are made during the term, with a larger final payment due on the maturity date.
- Deferred Payments — The parties may agree that payments begin after a specified period following closing.
The appropriate structure depends on the cash flow of the acquired business and the objectives of the parties.
Lesson 6
Interest Rates
Seller-financed transactions typically require the buyer to pay interest on the outstanding principal balance.
The Promissory Note generally specifies:
- Fixed or variable interest rate
- Interest calculation methodology
- Payment frequency
- Default interest rate (if applicable)
Interest provisions should comply with applicable law and accurately reflect the parties' agreement.
Lesson 7
Security Agreements and Personal Guarantees
Depending on the transaction, the seller may seek additional protections.
Examples include:
Security Agreement
A Security Agreement grants the seller a security interest in specified collateral securing repayment of the note.
Personal Guaranty
The buyer—or another individual or entity—may personally guarantee repayment if the acquiring entity fails to satisfy its obligations.
Not every transaction includes these additional protections, but they are commonly negotiated in seller-financed acquisitions.
Lesson 8
Events of Default
The Promissory Note identifies circumstances constituting a default.
Examples may include:
- Failure to make payments
- Bankruptcy or insolvency
- Breach of material covenants
- Unauthorized sale of collateral
- False representations
- Failure to maintain required insurance (where applicable)
The agreement also specifies the remedies available upon default.
Lesson 9
Remedies Following Default
If a default occurs, the Promissory Note and related agreements typically establish the seller's available remedies.
Depending on the negotiated terms, these may include:
- Accelerating the remaining balance.
- Charging default interest.
- Exercising rights against collateral.
- Enforcing a personal guaranty.
- Pursuing legal remedies.
- Recovering attorneys' fees where permitted by the agreement and applicable law.
The scope of available remedies depends on the transaction documents and governing law.
Lesson 10
Negotiating Seller Financing
Seller financing is often one of the most negotiated components of an acquisition.
Buyers commonly seek:
- Lower interest rates
- Longer repayment periods
- Flexible payment schedules
- Limited collateral requirements
- Broad prepayment rights
Sellers commonly seek:
- Larger down payments
- Shorter repayment terms
- Strong collateral
- Personal guarantees
- Higher interest rates
- Robust default protections
The final structure reflects the financial strength of the buyer, the risk profile of the business, and the parties' relative bargaining positions.
Lesson 11
Practical Example
Assume a buyer acquires a professional services firm for $2.5 million.
The transaction is structured as follows:
- A buyer acquires a professional services firm for $2.5 million.
- The transaction is structured as follows:
- $1.75 million paid in cash at closing.
- $750,000 financed by the seller.
- Five-year Promissory Note.
- Fixed interest rate.
- Monthly payments.
- Security interest in certain business assets.
- Personal guaranty from the buyer.
This structure allows the buyer to complete the acquisition with less cash at closing while providing the seller with additional income over time and contractual protections in the event of default.
Key Takeaways
What to remember from this module.
- Seller financing allows a portion of the purchase price to be paid over time rather than entirely at closing.
- The Promissory Note establishes the buyer's repayment obligations, including principal, interest, payment schedule, maturity, and default provisions.
- Seller-financed transactions may include Security Agreements and Personal Guarantees to provide additional protection for the seller.
- Payment structures, interest rates, collateral, and default remedies are among the most heavily negotiated financing terms.
- Properly structured seller financing can help facilitate transactions while balancing the interests of both buyers and sellers.
What's Next
Module 16 — Closing the Transaction
Learn what happens between signing and closing, how closing conditions are satisfied, the documents typically exchanged, and how attorneys coordinate the final steps to successfully complete a business acquisition.
Educational Disclaimer
The information contained in this course is provided solely for educational and informational purposes. It is intended to provide a general overview of seller financing and promissory notes in mergers and acquisitions and does not constitute legal, tax, accounting, investment, or financial advice. Reading this material or using the Transaction Academy does not create an attorney-client relationship with GV LAW PLLC. Every transaction is unique, and buyers and sellers should consult qualified professional advisors regarding their specific circumstances.