Seller financing vs bank financing to buy a business

What each source brings

A bank loan and a seller note are not two versions of the same thing. They sit in different places in the capital structure, carry different risks, and do different jobs for the deal.

The bank provides most of the money. The seller note provides something the bank cannot: capital that ranks behind the bank, so the bank's own loan is safer, and evidence that the person who knows the business best is betting on its future.

What a seller note can replace, and what it cannot

A seller note can replace part of the buyer's equity and part of the bank's loan. It cannot replace either entirely, and which part it replaces depends on its terms.

• A patient note replaces equity. If the note cannot be paid while the bank is outstanding, or can be paid only from excess cash with the bank's consent, the bank counts it as something close to equity. Under SBA rules a note on full standby, with no principal or interest paid for the life of the SBA loan, can count for up to half of the buyer's required equity injection. Interest may accrue and be paid after the SBA loan is repaid.
• An amortizing note replaces bank debt. A seller note that is paid on a schedule from day one is debt. It adds to the payments the business must cover, and it takes up room the bank would otherwise have lent. It lowers the cash the buyer needs at closing but does not usually lower the equity the lender requires.
• No note replaces the buyer's cash. Lenders want the buyer to have real money at risk. Under SBA the buyer's equity injection must be at least 10% of total project costs, and a standby note can cover no more than half of it. Conventional lenders set their own minimum and rarely accept a deal in which the buyer's cash is trivial.

A seller note that is paid like a bank loan is treated like a bank loan. Only patient seller paper does the work of equity.

The mix under SBA, worked through

Take an SBA-financed purchase with total project costs of 1,000, and a business whose cash flow comfortably services a loan of 900 at SBA's standards. Three ways to structure it:

The standby note halves the buyer's cash without changing the bank loan. The amortizing note shrinks the bank loan but not the buyer's cash, and its payments count in debt service. SBA requires debt service coverage of at least 1.15x, and from 1 October 2026 a change of ownership must show 1.25x on historical results, with the seller note's payments included wherever the note is not on standby. A deal that works with a standby note can fail coverage with the same note amortizing.

SBA also prohibits an earnout to the seller in a change of ownership it finances, so deferred price that depends on future performance has to be restructured as a fixed note; see earnout vs seller note. The seller may not remain as an owner, officer or employee, and may consult for up to 12 months after closing, up to 24 months under SOP 50 10 8.1 from 1 October 2026. How much seller paper is typical, and how to negotiate it, is in how much seller financing and seller notes and SBA's full-standby rule.

The mix in a conventional deal

Conventional banks and private credit funds have no single standby rule. Each writes its own subordination terms, and those terms decide how the lender counts the note. The common pattern: the seller note is subordinated in right of payment and lien, payments stop if the senior loan is in default or a covenant is breached, and the seller cannot accelerate or sue while the senior loan is outstanding. Many lenders allow interest, or interest and some principal, as long as coverage stays above a set level. The details are covered in seller note subordination terms and seller note terms in conventional deals.

The lender then sizes its own loan around the note. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA. If a business earns EBITDA of 1,000 and sells for 5,000, a senior lender at 3,000 leaves 2,000 to fill. A seller note of 1,000 on patient terms and 1,000 of buyer equity closes that gap. A seller note of 1,000 that amortizes quickly may push total debt service past what the lender will accept, and the lender cuts its own loan to compensate. Conventional bank lenders commonly look for debt service coverage of at least 1.25x across all the debt.

This is the sense in which the note changes the bank's loan. The more patient the seller paper, the more of the price the senior lender can fund and the less cash the buyer needs. The more the seller insists on being paid alongside the bank, the smaller the bank's loan and the larger the gap. Where the gap is too large for seller paper, other layers come in; see mezzanine vs seller note and rollover equity vs seller note.

Why sellers agree to carry paper

Buyers are sometimes surprised that sellers accept being paid later, behind a bank. Sellers do it for reasons that are mostly in their own interest:

• A higher price. Seller financing is the usual way to bridge a gap between what the seller wants and what a bank will lend against. A seller who will not carry paper often has to accept a lower price.
• More buyers. Few individual buyers or searchers can close without it. Refusing seller financing narrows the field.
• Financing that closes. Lenders read a seller note as the seller's confidence. A seller who will not carry anything invites the question of what they know.
• Tax timing. Receiving part of the price over time may spread the tax on the gain. That is a question for the seller's tax advisor, but it is often part of the motive.
• Interest income. The note earns interest, even if it is paid late.

The seller's risk is real. The note is behind the bank; if the business struggles, the bank is paid first and the seller may wait years or lose part of the note. For a retiring owner who needs the proceeds to live on, that risk shapes how much they will carry and on what terms.

When the seller finances everything

Some small businesses sell with the seller as the only lender: the buyer pays a down payment and the seller carries the rest over several years. It avoids a bank's underwriting and paperwork, and for a very small business that no lender will finance on its own, it may be the only way a sale happens.

For a buyer it is rarely the better deal when bank financing is available. The seller usually wants a shorter term than a bank, often with a balloon, and keeps the right to take the business back on default. The buyer gets no outside check on the price: no lender underwriting, no business valuation, no quality of earnings. And the seller stays involved as a creditor for years. A bank loan with a modest, patient seller note puts an outside lender's judgement on the deal and usually gives the buyer longer terms. The seller who carries it all, meanwhile, holds the full risk of the buyer's success on a single loan.

Later, a seller note can often be refinanced once the business has a record under its new owner, subject to the senior lender's terms; see refinancing seller notes.

Building the mix before the letter of intent

The seller note's size, rate, amortization and standby terms should be set with the lender's rules in mind before the letter of intent is signed, not negotiated after the bank has sized its loan. A letter that promises the seller monthly payments from closing may make an SBA structure impossible and a conventional one smaller. See financing contingencies in the LOI and sources and uses.

The lender will ask for the target's latest full year of figures and the letter of intent, alongside the buyer's documents: for an SBA loan, two to three years of business and personal tax returns, a P&L and balance sheet with a year-to-date P&L, a debt schedule, and a personal financial statement for each 20% owner. Transparent's lender book holds 1,800+ lenders, including 278 writing SBA 7(a) and 504 and 1,148 writing term and private credit, so the same deal can be shown with the seller note on standby and with it amortizing, and the buyer and seller can see what each version does to the bank's loan before they agree the terms.