A senior lender will let a seller note be paid, but only as junior debt: the seller signs a subordination agreement that stops payments while the senior loan is in default, often lets payments be made only if the business passes its covenants afterwards, bars the seller from suing or accelerating for a set standstill period, and puts any lien the seller holds behind the lender's. These terms are standard, not a sign of a difficult lender. The risk is timing: if the seller has not agreed to them in the letter of intent or purchase agreement, they surface at closing.
- Who signs
- The seller, the senior lender and the borrower
- Payments allowed
- Scheduled payments, unless a block applies
- Payment blockage
- On a senior payment default, and often on a covenant default
- Standstill
- The seller cannot enforce the note for a set period after a default
- Security
- Unsecured, or a lien that ranks behind the senior lender's
- When to agree it
- In the letter of intent, then the purchase agreement
Why a senior lender cares about the seller's note
A seller note is part of the price the seller agrees to receive later, as a loan to the buyer. To the buyer it is a way to pay less at closing. To the senior lender it is a second creditor with a claim on the same cash flow and, sometimes, the same assets. The lender has sized its loan on the business's earnings, and it will not let a second creditor be paid ahead of it, or alongside it, when that cash is needed for the senior loan.
In an SBA deal the answer is blunt: a seller note that is to count toward the buyer's equity must go on full standby for the life of the SBA loan, with no principal or interest paid. Conventional lenders, meaning banks, private credit funds and unitranche lenders lending outside the program, are more flexible. They generally accept a paying seller note. What they require in return is a set of subordination terms that decide exactly when the seller may be paid and what the seller may do if the note is not paid. Those terms live in a subordination agreement signed by the seller, the lender and the borrower, and the note itself is written to refer to it.
None of this is unusual, and the terms below are close to a market standard. What makes them dangerous is that sellers often have not seen them before, and a seller who learns at closing that the note can be blocked tends to ask for the price to change.
The terms, one by one
A subordination agreement for a seller note usually contains six kinds of term. The table sets out what each does and where sellers usually push back.
| Term | What it does | Where sellers usually push |
|---|---|---|
| Payment subordination | The senior loan is paid in full before the seller in a liquidation or bankruptcy; the seller turns over anything received in breach | Rarely contested; this is what junior means |
| Payment blockage on a payment default | If the borrower misses a senior payment, no seller payment may be made until it is cured | Accepted by most sellers once explained |
| Payment blockage on a covenant default | If a senior covenant is breached, seller payments stop for a blockage period, which can recur | Sellers ask to limit how long a block lasts and how often it can be imposed |
| Payment conditions | Each seller payment is allowed only if there is no default and the business passes its covenants after the payment | Sellers ask for the test to be the covenant level, not a stricter one |
| Standstill on enforcement | The seller may not accelerate, sue or enforce security for a set period after a default, or while the lender is acting | Sellers ask for a shorter period and a right to act if the lender does nothing |
| Limits on amendments and security | The note cannot be made shorter, pricier or better secured without the lender's consent; any lien is junior | Sellers ask for a junior lien where the lender will allow one |
Payment blockage is the heart of it. A block on a payment default is automatic. A block on a covenant default is triggered by the lender's notice and lasts for a fixed period unless the default is cured or waived first. Well-drafted agreements limit how many covenant blocks can be imposed in a year, and that limit is the term most worth a seller's negotiating effort.
Payment conditions go further than blockage. Instead of waiting for a default, the credit agreement tests each seller payment before it is made: no default is continuing, and the business still passes its leverage and fixed charge coverage covenants after paying. Seller-note payments usually count as fixed charges, so the payment is part of the test it has to pass.
Standstill protects the lender's control of a workout. Without one, a seller could accelerate the note and trigger a cross-default into the senior loan at the worst moment. The standstill gives the senior lender a period in which it alone decides whether to waive, restructure or enforce.
A blocked payment is deferred, not forgiven: it keeps accruing and is paid when the block ends, unless the note says otherwise.
A payment test in plain numbers
Take a business with cash flow available for debt service of 1,500 a year. Senior debt payments are 1,000 and the seller note calls for 200. The credit agreement requires fixed charge coverage of at least 1.25x, counting seller-note payments as fixed charges.
| Year | Cash flow | Senior payments | Seller payment due | Coverage with the seller payment | Seller paid? |
|---|---|---|---|---|---|
| Year one | 1,500 | 1,000 | 200 | Exactly 1.25x | Yes |
| Year two, softer year | 1,400 | 1,000 | 200 | Below 1.25x | No: blocked and deferred |
| Year three, recovery | 1,650 | 1,000 | 200 plus the deferred 200 | Above 1.25x on the current payment | Current payment yes; the catch-up no, because coverage with it falls below 1.25x |
Two points come out of the example. A seller note that looks small against the price can be large against a covenant cushion, because every seller payment comes out of the same margin above the covenant that protects the senior loan: here, 200 of payments consumed the whole cushion in year one. And the catch-up in year three is where disputes start. Paying the current 200 leaves coverage of 1,650 against 1,200, above 1.25x; adding the deferred 200 brings it to 1,650 against 1,400, below 1.25x, so the catch-up waits another year. The agreement should say when deferred amounts are paid and whether interest runs on them while they wait. How coverage covenants are built is covered in debt service coverage ratio and covenant headroom.
Maturity, acceleration and security
Beyond payments, the senior lender will look at three features of the note itself.
- Maturity. Lenders commonly want the seller note to mature after the senior loan, or at least to have no large final payment due while the senior loan is outstanding.
- Acceleration. The seller's right to call the whole note due on default is limited by the standstill, and the note's own events of default are usually narrowed: a missed seller payment caused by a lawful block is not a default under the note. Otherwise the subordination agreement blocks a payment and the note treats the block as a default, which is circular.
- Security. Some lenders want the seller unsecured. Others allow a junior lien on the business assets, subject to an intercreditor or subordination agreement that bars the seller from enforcing it while the senior loan is outstanding and requires the lien to be released when the senior lender sells collateral. Where the seller is offered a lien, what an intercreditor agreement settles explains the mechanics.
Settle it in the letter of intent, not at closing
Seller-note terms rarely break a deal because the seller refuses them. They break it because the letter of intent said nothing about subordination, the purchase agreement copied the silence, and the lender's form arrived in the final week. By then any condition on the seller's schedule looks like a price cut.
The fix is to write the principle into the letter of intent and the detail into the purchase agreement, before a lender's form exists.
| Document | What to settle about the seller note |
|---|---|
| Letter of intent | That the note will be subordinated to senior acquisition financing on the senior lender's customary terms, including payment blockage and standstill; whether it is secured |
| Lender term sheet | The lender's specific conditions: which defaults block payment, whether payments are tested against covenants, the standstill period, maturity relative to the senior loan |
| Purchase agreement and note | The note's rate, amortization and maturity, consistent with the term sheet; the buyer's right to offset indemnity claims; the seller's agreement to sign the lender's subordination agreement |
| Subordination agreement | The final terms, negotiated among seller, lender and borrower before closing |
A buyer who has an early read from a lender before signing the letter of intent can put the lender's likely terms in front of the seller at the start. What a lender can tell you before the LOI covers what that early read includes. The letter of intent is also where the buyer should protect itself with a financing condition written around the structure, set out in the financing contingency in an LOI.
What a seller can reasonably ask for
A seller who accepts subordination is not powerless. Terms that lenders commonly accept, when asked early:
- Scheduled interest payments whenever no block is in place, even if principal is held until later.
- A cap on how many covenant blocks can be imposed and for how long in total.
- A higher interest rate on amounts deferred by a block, compensating the seller for waiting.
- A personal guarantee from the buyer, which senior lenders often allow because it does not touch the business's cash, usually on condition that the seller cannot enforce it while a block or standstill is running.
- Copies of the compliance certificates the borrower sends the senior lender.
What sellers rarely get is a right to be paid regardless of covenants, a lien that ranks equally with the senior lender, or a maturity inside the senior loan's term. Those are not negotiating positions; they turn the seller's note into senior debt, and the senior lender would size its own loan down to match. Seller note terms in conventional deals sets out typical rates and amortization, and mezzanine vs a seller note compares seller paper with the institutional junior debt it often replaces.
How this differs from SBA full standby
| Conventional subordination | SBA full standby | |
|---|---|---|
| Payments while the senior loan is outstanding | Allowed unless blocked or the payment test fails | None: no principal, no interest |
| Counts toward the buyer's equity | Lenders treat it as junior debt in leverage; it lowers the cash the buyer brings | Up to half of the required equity injection |
| Counted in coverage | Yes, its payments are tested | No, nothing is paid |
| Seller's remedies | Limited by a standstill | None while the SBA loan is outstanding |
| Interest | Paid when not blocked | May accrue and be paid after the SBA loan is repaid |
For the seller, conventional subordination is usually the better trade: the note is paid most of the time. SBA 7(a) vs a conventional acquisition loan compares the two routes.
Transparent's financing model shows the seller note's payments year by year beside the senior debt service and the covenant tests, so the seller and the lender can both see in advance when a block would bite. It is part of the lender package, built in a day once the documents are in.
Common questions
- Can a senior lender stop payments on a seller note?
- Yes, on the terms the seller signs. A payment default on the senior loan blocks seller payments automatically, and most agreements let the lender block them for a period after a covenant default too. Blocked amounts are usually deferred, not forgiven.
- Does the seller have to sign anything with the buyer's lender?
- Yes. Conventional lenders require the seller to sign a subordination agreement with the lender and the borrower. The purchase agreement should say the seller will sign it on the lender's customary terms.
- Can a seller note be secured behind a senior loan?
- Sometimes. Some lenders require the seller to be unsecured; others allow a junior lien the seller cannot enforce while the senior loan is outstanding and must release when the lender sells collateral.
- What happens if the seller refuses subordination terms at closing?
- The lender will not close with an unsubordinated note, so the choices are to renegotiate the note, replace it with more equity or other junior capital, or not close. That is why the terms belong in the letter of intent.
- Is conventional subordination the same as SBA full standby?
- No. Under full standby nothing is paid for the life of the SBA loan. Under conventional subordination the seller is paid on schedule unless a block or a failed payment test stops a payment.