Most acquisitions of companies with $10M to $100M+ in revenue use both. A bank or private credit fund provides the senior loan, secured first and repaid first. The seller note sits behind it, subordinated. If it is patient, accruing its interest and due after the senior loan, lenders treat it as support close to equity: it fills part of the gap between the price and what the senior lender will lend, and it shows the seller believes in the business. If it is paid on a schedule from closing, it is debt, and its payments shrink the senior loan.
- Senior loan
- Bank or private credit; secured, repaid first; the largest share of most purchases
- Seller note
- Subordinated to the senior lender; paid from what is left
- A patient note
- Accrues and waits; leaves coverage untouched and can count toward the cushion
- A paying note
- Debt service like any loan; reduces what the senior lender will lend
- Earnouts
- Allowed by many conventional lenders, subordinated like a note
- The real decision
- Size and terms of the seller note, which change the senior loan
What each source brings
A senior 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.
| Senior loan (bank or private credit) | Seller note | |
|---|---|---|
| Position | Senior, first lien on the company's assets | Subordinated to the senior lender, by a subordination agreement the lender requires |
| What the lender underwrites | Historical cash flow, leverage, collateral, the buyer's equity and experience | The seller already knows the business; the note is part of the price negotiation |
| Repayment | Scheduled amortization at a bank; light amortization at many private credit funds | Whatever the senior lender permits: amortizing, interest-only, accruing, or on full standby |
| Security | All business assets; personal guarantees in some owner-led deals | Usually a lien behind the senior lender, if any |
| Cost to the buyer | Market rate for senior risk | Negotiated; often modest, since the seller is also selling the business |
| What the seller gets | Cash at closing | A promise to be paid later, behind the senior lender |
| Signal to lenders | None | The seller is willing to wait for part of the price, which is confidence in the business |
The senior lender provides most of the money. The seller note provides something the senior lender cannot: capital that ranks behind it, so its 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 senior 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 senior loan is outstanding, or can be paid only from excess cash with the lender's consent, many senior lenders count it as something close to equity. A note on full standby, paying no principal or interest until the senior loan is repaid, is the strongest version; interest can accrue and be paid afterwards.
- An amortizing note replaces senior debt. A seller note that is paid on a schedule from day one is debt. It adds to the payments the company must cover and takes up room the senior lender 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, or the buyer's investors, to have real money at risk. Each lender sets its own minimum equity, and few accept a deal in which the new cash is trivial.
A seller note that is paid like a senior loan is treated like one. Only patient seller paper does the work of equity.
The mix, worked through
Take a company earning EBITDA of 1,000, with cash flow available for debt service of 900 after taxes and maintenance capital spending, sold for 5,000. A senior lender will lend 3,000, three times EBITDA, inside the 2x to 3.5x range senior cash-flow lenders to lower-middle-market companies commonly lend, with debt service of 600 a year. Conventional bank lenders commonly look for debt service coverage of at least 1.25x. Three ways to fill the remaining 2,000:
| No seller note | Accruing seller note | Amortizing seller note | |
|---|---|---|---|
| Senior loan | 3,000 | 3,000 | 3,000 at first |
| Seller note | None | 1,000, accruing until the senior loan is repaid | 1,000, paid over five years |
| Buyer's equity | 2,000 | 1,000 | 1,000 |
| Annual debt service | 600 | 600 | About 860 |
| Coverage on 900 of cash flow | 1.5 times | 1.5 times | About 1.05 times |
| What the lender does | Lends as planned | Lends as planned; may credit the note toward the cushion | Cuts the senior loan until coverage works |
The accruing note halves the buyer's cash without changing the senior loan. The amortizing note lowers the buyer's cash on paper, but its payments push coverage below where the lender is comfortable, so the lender shrinks its own loan and the gap reopens. A deal that works with a patient note can fail with the same note amortizing.
Deferred price that depends on future performance is a separate choice. Many conventional lenders accept an earnout, subordinated like a note, but they will size their loan around the possibility it is paid. How much seller paper is typical, and how to negotiate it, is in how much seller financing.
How senior lenders write the subordination
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.
Lenders also want the note's maturity after the senior loan's, no cross-default that lets the seller act on a senior default, and no security, or security only behind the senior lender. A seller who insists on monthly payments, a first-lien position or a right to take the business back is asking to be treated as a second senior lender, and the senior lender will size its own loan accordingly.
This is the sense in which the note changes the senior 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 senior lender, the smaller the senior 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 senior lender. 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 senior lender will lend against. A seller who will not carry paper often has to accept a lower price.
- More buyers. Many independent sponsors and searchers close with some seller paper. Refusing it 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 senior lender; if the business struggles, the lender 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. Some sellers prefer to keep a stake instead, through rollover equity.
Why the seller rarely finances everything
At this size a sale financed entirely by the seller is rare. A seller of a company with $10M to $100M+ in revenue usually needs most of the price in cash at closing, and a buyer usually gets longer terms and a lower cost from a senior lender than from a seller who wants to be paid quickly.
There is a second reason buyers want an outside lender in the deal. A senior lender's underwriting, the quality of earnings review it relies on and the covenants it sets are an independent check on the price. A seller who finances everything supplies none of that, keeps the right to take the business back on default, and stays involved as a creditor for years. A senior loan with a modest, patient seller note puts an outside lender's judgement on the deal.
Later, a seller note can often be refinanced once the company 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 sizing in mind before the letter of intent is signed, not negotiated after the senior lender has sized its loan. A letter that promises the seller monthly payments from closing may make the senior loan smaller than the buyer planned. See financing contingencies in the LOI and sources and uses.
The lender will ask for the target's latest full year of figures for every company being bought, never an older year, and the letter of intent, alongside the P&L, a year-to-date P&L through last month-end, the balance sheet and a debt schedule. Midas Partners's lender book holds 1,800+ lenders, 1,148 of them writing term and private credit, and the financing model shows the deal with the seller note accruing and with it amortizing, so buyer and seller can see what each version does to the senior loan before they agree the terms. Once the documents are in, the full lender package is built in a day; by hand, the same package takes at least a week.
Common questions
- Is seller financing better than a bank loan?
- Not as a replacement. A senior loan provides most of the price at longer terms with an outside check on the deal. A seller note works best alongside it, subordinated and patient, filling part of the gap and signaling the seller's confidence.
- Does a seller note count as equity?
- Not usually as cash equity. Many senior lenders will credit a deeply subordinated note, accruing its interest and due after the senior loan, toward the cushion beneath their loan. A note that is paid on a schedule is debt and counts in debt service.
- Will the senior lender let me pay the seller while its loan is outstanding?
- Often, within limits. Lenders commonly allow interest, and sometimes some principal, while the senior loan is current and coverage stays above a set level, and block payments after a default or covenant breach.
- Can the seller take an earnout instead of a note?
- With many conventional lenders, yes, subordinated like a seller note. The lender will size its loan around the possibility that the earnout is paid and will want its payments tied to the same coverage conditions as a note's.
- How big should the seller note be?
- Big enough to close the gap between the price and what the lender and buyer can fund, and on terms patient enough that the lender counts it as support rather than more debt. The right size comes from the lender's sizing, which is why the mix should be tested before the letter of intent.