• Seller’s paper, alternatively called seller note or seller debt, refers to the financial instrument sellers use for owner or seller financing.
• In this agreement, sellers agree to receive payments in installments from a buyer instead of an upfront payment at purchase.
• There are many uses for seller’s paper, but a common one is where sellers agree to a price higher than what buyers can pay upfront. The seller’s paper covers the difference, allowing the buyer to pay it off over time.
• Seller’s paper makes property purchase smoother and more manageable for buyers, but sellers should keep in mind that many types of seller financing aren’t secured, so they may have no way to recoup their loss if the buyer defaults.

When sellers issue this note, they essentially lend money to the buyer. The buyer commits to clear the debt by making payments over time, as laid out in the terms of the agreement.

The buyer makes regular payments until they clear the total balance, renegotiate the terms, or otherwise come to a new agreement with the seller. If buyers delay payments or breach the terms of the contract, the seller may have legal recourse, typically outlined in the agreement itself.

Seller’s paper, as a type of debt financing, usually carries interest. Sellers profit by imposing interest on the amount they lend to buyers. The note will detail the total money owed, the applied interest rate, and the due dates of payments.

Additionally, seller’s papers often subordinated debt, meaning they rank below certain other types of debt (like bank loans)[1]. This position in the debt hierarchy means that, in case of loan default or bankruptcy, sellers get repaid only after other creditors that hold more senior debt have been paid in full.

RELATED: How a Mortgage Closing Works (Seller Financing Tutorial)

Seller’s papers are useful in different scenarios, based on the situation and the purpose of seller financing.

Fill the Gap

Seller’s papers commonly fill the gap between what buyers can pay upfront and the total price that sellers demand.

For example, if buyers can’t pay the full price upfront, sellers can issue a note for the remaining amount to close the deal[2].

Fund Buy-Sell Agreements

A buy-sell agreement sets a sale’s terms and conditions[3] between sellers and buyers. Seller’s papers often finance parts or all of such agreements.

Purchase Real Estate Properties

Many sellers use seller’s papers to give buyers finance options, making property purchases easier. They also come in handy for down payments. Specifically, they are used when sellers decide to finance part or all of the amount.

Stretch Purchase Price

Though traditional financing often covers an acquisition’s market purchase price, sellers may use seller notes to extend the available financing beyond what traditional lenders provide. This is particularly helpful when buyers lack the funds to cover the purchase price upfront, leading sellers to issue a note to facilitate the sale.

Acquire Businesses

Buyers often use seller notes as an acquisition strategy to purchase a company, reducing the immediate cash outlay at closing.

Maintain a Continuing Interest

In situations where sellers retain an ongoing role in the business after the sale, seller notes can allow sellers to maintain a financial interest in the business. This can be particularly beneficial if sellers want to participate in the future growth or profitability of the business[4].

One way to retain control of a business post-sale is to be a member of the company’s board.

Below are common types of seller’s paper:

1. Contractual Subordination

Contractual subordination is an agreement where sellers rank their notes below other claimants. If a loan defaults, sellers get repaid only after banks fully recover their money[5]. This note is legally enforceable between sellers and buyers.

However, it doesn’t necessarily cross-default to other seller notes or third-party financing, meaning that a default on this note does not automatically cause a default on other financing arrangements. As a result, sellers aren’t exposed to risks tied to additional seller notes or financing.

2. Payment-In-Kind

These notes are a type of payment that sellers can offer buyers instead of cash payments. Also, these notes typically have only interest or deferred payments, so sellers get their money back over time, not all at once.

These seller notes often carry conditions to protect the seller’s interests. For instance, sellers may demand buyers offer collateral or repayment guarantees before issuing the seller note.

3. Full Covenants and Defaults

This seller note usually includes a comprehensive set of covenants and default clauses. It’s often accompanied by collateral or guarantees if buyers fail to meet the repayment terms.

4. Prepayments or Redemptions

Some sellers issue notes with prepayment or redemption clauses. These clauses allow or demand early repayment of the seller note, typically at a rate higher than initially agreed.

Even though prepayments or redemptions ask for payments in advance, they often allow for refinancing as needed, potentially without extra charges, call premiums, or mandatory non-call periods[6], depending on the specific terms of the note.

Sellers gain many advantages but also face some risks when using a seller note.

Benefits

• Flexibility – Seller’s papers give sellers greater flexibility in financing an asset purchase.
• Control – This financing type can provide sellers with an ongoing interest in the business or property, as they often agree to subordinate their notes to other claimants.
• Increased Likelihood of Closing Transactions – Seller’s paper can give sellers a competitive advantage, as buyers are likelier to accept its terms.
• Boosted Total Value – Sellers can achieve a higher overall value for their business by earning interest over the life of the loan[7].

Risks

• Unreliability – Sellers need to make sure the buyer will fulfill their repayment duties.
• Default Risk – In a worst-case scenario, sellers may struggle to recover their money if buyers fail to repay.
• Unsecured Notes – Some seller notes are unsecured, which means sellers lack any security to recoup their losses if a borrower defaults.
• Uncertain Arrangements – While legally binding, the terms in seller notes may need to be renegotiated to adapt to changing circumstances, such as the buyer encountering financial difficulties[8].

1. Hayes, A. (2020, November 30.)  Senior Debt: What It Is, Why It’s Less Risky. Investopedia. Retrieved from https://www.investopedia.com/terms/s/seniordebt.asp
2. Dickes, F. (2021, July 26.) Seller Notes: What They Are and How They Work. Hadley Capital. Retrieved from https://www.hadleycapital.com/insights/selling-a-small-business/seller-notes
3. Buy-Sell Agreement (2021, November.) Legal Information Institute. Retrieved from https://www.law.cornell.edu/wex/buy-sell_agreement
4. Why Seller Paper May Be A Viable Financing Solution. (2005, November.)  Bank of America Business Capital. Retrieved from https://pages.stern.nyu.edu/~igiddy/articles/seller_paper.pdf
5. Subordination. (2021, October.) Legal Information Institute, Cornell Law School. Retrieved from https://www.law.cornell.edu/wex/subordination
6. Prepayments and accruals. (n.d.) Accounting Sage. Retrieved from https://help.accounting.sage.com/en-ie/accounting/cashflow/extra-prepayments-and-accruals.html
7. Chen, J. (2022, May 28.) How Debt Financing Works, Examples, Costs, Pros & Cons. Investopedia. Retrieved from https://www.investopedia.com/terms/d/debtfinancing.asp
8. Ponder, G. (2022, May 19.) What is an earnout? What is a seller note? Protections to consider when selling a business. Viking. Retrieved from https://www.vikingmergers.com/blog/2022/what-is-an-earnout/