Financing

Updated April 17, 2026

Seller financing: how it works and what protects the seller

Most small trades-business sales include some form of seller financing. The seller carries a note for part of the price and is paid back over time. Done well, it makes the deal possible. Done poorly, it puts most of the seller's retirement at risk if the buyer defaults.

Why almost every internal sale uses seller financing

Internal buyers (a long-tenured employee, a partner, a family member) almost never have the full purchase price in cash. SBA 7(a) loans typically cover up to 85% to 90% of an acquisition with the rest expected as buyer equity or seller financing. The IBBA Market Pulse Survey shows that for small business transactions under $1M, seller financing is included in a substantial majority of deals.

From the buyer's perspective, seller financing reduces the upfront cash needed and signals that the seller believes the business will continue to perform. From the seller's perspective, it is the difference between a deal closing and a deal not closing. It is also significant ongoing risk that needs to be structured carefully.

Typical structure

A common structure for small trades-business sales: 60% to 80% paid at closing (often via SBA 7(a) loan to the buyer), with the remainder financed by the seller as a promissory note paid over 3 to 7 years at an interest rate at or above the SBA's published market rate.

The seller note is typically subordinate to the SBA loan, meaning if the business goes under, the SBA lender gets paid first. The SBA requires this for 7(a) loan participation. The seller's recovery in a default scenario depends on what is left after the senior lender is satisfied.

Interest rates on seller notes are negotiable but typically priced at or near the SBA loan rate or slightly above. The IRS publishes the Applicable Federal Rate (AFR) monthly. The seller note's stated interest must be at least the AFR or the IRS may impute interest, with tax consequences for both parties.

Protections to negotiate into the note

Personal guarantee from the buyer. Without it, only the business is on the hook. With it, the buyer's personal assets are too. SBA 7(a) loans almost always require a personal guarantee from any owner of 20% or more of the business; the seller note typically tracks the same standard.

Pledged collateral. The buyer's equity in the business itself plus key business assets (vehicles, equipment) can be pledged as collateral. Real estate, if owned, may be a separate transaction.

Cure rights and acceleration. The note should specify what counts as default (typically missed payments after a stated cure period) and what the seller can do (accelerate the full balance, take back ownership of the business in extreme cases). Any take-back provision must be drafted carefully or it becomes unenforceable.

Right to financial reporting. The note should require the buyer to provide quarterly or annual financials so the seller can monitor the business's ability to make payments.

Restrictive covenants on the buyer. Common covenants: no additional debt above a stated threshold without the seller's consent, no major equipment sales, no change in business model. These protect the asset that the note is secured against.

Tax treatment of seller financing

If the seller receives payment over more than 1 tax year, the IRS Installment Method (Form 6252) typically applies. Each payment is part return of basis, part gain, part interest. This can spread the tax liability over the payment period.

Depreciation recapture on equipment is generally not eligible for installment treatment and is recognized in the year of sale. The CPA running the deal should model after-tax cash flow under the chosen structure before closing.

The IRS publishes installment-sale rules in Publication 537.

When seller financing is the wrong call

If the seller cannot afford to lose the seller-financed portion of the price, seller financing is the wrong call. The note is contingent on the business continuing to perform. If the buyer mismanages it, the buyer defaults, and recovery is limited, the seller may receive a fraction of what was owed.

Sellers who need the full proceeds for retirement should look harder at all-cash buyers (typically meaning a lower purchase price with a strategic or PE-backed buyer) or structure the deal so the seller-financed portion is no more than the seller can afford to lose.

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