The Seller Note Counts as Equity, or as Debt. The Terms Decide.

A seller note is usually negotiated as part of the price. The senior lender reads it as part of the capital structure, and the terms decide which side of the line it falls on.

Buyers ask for seller notes to reduce the cash they have to write at closing. Whether a note actually does that depends on a handful of provisions that are typically settled after the price, often by lawyers, and frequently without anyone modelling what each one does to the financing.

The same note, at the same size, can be worth millions of dollars of the buyer’s own money.

One acquisition, two versions of the same note

Take an illustrative case. A buyer is acquiring a wholesale distributor for $18 million, five times $3.6 million of EBITDA. The senior lender will go to 3.0 times total debt and wants a 30 percent equity contribution. The seller agrees to a $3 million note as part of the consideration.

Version one: the note is on full standby. No cash interest and no principal while the senior loan is outstanding, interest accrues, maturity sits beyond the senior maturity, and the note is contractually subordinated with no enforcement rights.

The lender treats it as equity-like. Senior debt goes to 3.0 times, which is $10.8 million. The seller note covers $3 million. The buyer writes $4.2 million.

Version two: the note pays 8 percent current interest and amortizes from year two. Commercially reasonable, and what most sellers ask for.

Now it is debt. Total debt would be $13.8 million, or 3.83 times, well past the 3.0 cap, so the senior lender sizes down to $7.8 million to leave room for it. The buyer writes $7.2 million.

Same price. Same seller. Same $3 million note. $3 million more of the buyer’s own cash, decided by payment terms.

The five terms that decide it

Each of these is negotiable, and each one on its own can move a note from one category to the other.

Cash interest. A note that accrues interest and pays it at the end behaves like equity for coverage purposes. A note paying monthly interest is a fixed charge, and it enters the coverage test alongside the senior loan.

Principal before senior repayment. Any scheduled amortization while the senior loan is outstanding makes the note debt. Payment in full after the senior loan is retired is the standby position.

Maturity. A note maturing before or alongside the senior facility creates a refinancing event the senior lender has to underwrite. Maturity beyond the senior loan removes that.

Enforcement rights. The subordination agreement decides whether the seller can accelerate, sue, or act on collateral. A standby note typically has a payment blockage on default and a standstill on enforcement, and either no liens or liens fully subordinated.

Control rights. A seller holding board seats, consent rights or an equity stake alongside the note changes the analysis, and in some programs disqualifies the treatment entirely.

What the SBA now requires, as of last week

For smaller acquisitions the rule is written down rather than negotiated, and it changed on October 1, 2026, when the current version of the SBA’s lender operating procedures took effect.

Only debt on full standby, defined as no payments of principal or interest for the term of the 7(a) loan, may be counted as equity. It must be documented on the SBA’s standby form with the note attached, the standby creditor must subordinate its liens and take no action without the lender’s consent, and the provider of standby debt may not take an equity investment in the business. Interest may accrue and be amortized after the 7(a) loan is repaid.

Two further points matter for structuring. Seller debt on full standby is a limited equity source, and limited sources together may provide no more than half of the required injection. And for an initial acquisition the minimum injection is 10 percent of total project cost, which cannot be reduced or eliminated.

So on a $5.3 million project cost, the required injection is $530,000, of which a standby seller note can supply at most $265,000. The rest is unborrowed cash. Separately, total debt supporting the transaction, including seller debt that is not on full standby, is capped at the business valuation and has to be supported by debt service coverage.

How to negotiate it without losing the seller

A full standby note is a worse deal for the seller, and pretending otherwise wastes everyone’s time. Three things usually get it done.

Pay for the wait. A higher accrual rate on a standby note costs the buyer nothing in cash during the senior term and compensates the seller for the deferral. The lender does not object, because nothing is being paid.

Give certainty instead of cash. A seller who cannot be paid currently can be given a defined payoff date, a step-up on refinancing, or a prepayment right the buyer intends to use. Many sellers value a known end date more than monthly interest.

Split the note. A smaller current-pay tranche inside the senior lender’s coverage headroom, and a larger standby tranche treated as equity, is often the structure that clears both tests. It also turns the conversation from a binary into an allocation.

The one approach that does not work is agreeing a note in the letter of intent and sending the terms to the lender afterwards. By then the price is fixed, the seller has anchored on current payments, and the buyer absorbs the difference in cash.

How Thalos Capital Approaches This

Thalos Capital works borrower-side on strategic debt from $50 thousand to $100 million and above, across the United States: acquisitions, ownership transitions, recapitalizations and partner buyouts.

On an acquisition with seller financing, the work is to model the note both ways before the terms are agreed, so the buyer knows what each provision is worth in cash at closing, and to put the structure to more than one source. Senior lenders differ on what they will treat as equity-like, on how much coverage headroom they will allow a current-pay tranche, and on whether accrual counts in the coverage test.

The buyer in the example negotiated the price for six weeks and the note terms in an afternoon. The afternoon was worth $3 million.

Most financing situations have more options than the borrower initially sees. A conversation is enough to map them. Submit your financing request at https://thaloscapital.com/contact.