Seller Financing in M&A Transactions
A Legal Perspective for Buyers and Sellers
Why Buyers and Sellers Should Understand Seller Financing in M&A
In the evolving world of mergers and acquisitions, seller financing has become a widely adopted mechanism to fund acquisitions, especially in lower-middle-market deals across the U.S. As a business owner or entrepreneur preparing to buy or sell a business, understanding the legal, financial, and operational impact of seller financing is crucial. This method can close funding gaps, bridge valuation disagreements, and align interests when structured with the right protections in place.
Seller financing is a fantastic tool for Buyers because 1) it allows Buyers to purchase businesses that they may not have the credit to purchase otherwise, 2) interest terms are typically more favorable than those of bank loans, and 3) earnout terms align the Seller’s and Buyer’s business objectives in a way that derisks the purchase for the Buyer.
Seller financing is also a helpful tool for Sellers because 1) Sellers can command a higher sales price, 2) it allows for beneficial tax planning, and 3) it may make your unsellable business sellable.
What is Seller Financing?
Seller financing refers to an arrangement where the Seller of a business agrees to accept a portion of the purchase price over time through a promissory note, rather than in full at closing. This transforms the Seller into a lender and introduces a layer of financial interdependence into the deal. Common in deals under $50 million, seller financing is a flexible option when bank or Small Business Association (SBA) financing falls short, or when valuation disagreements call for creative resolutions.
Key legal documents involved include:
- Asset Purchase Agreement or Stock Purchase Agreement – In addition to provisions customary to M&A transactions, in a seller financing arrangement, the Purchase Agreement will contemplate the amount the Seller is seller-financing, which is frequently tied to earnout and performance terms. Often the Seller will earn a larger seller-financed amount where the company achieves certain metrics that are good for the Buyer.
- Promissory Notes – The foundational document outlining repayment terms of the seller-financed component of the transaction, including payment schedule, interest terms, consequences of default, and forgiveness terms.
- Security Agreements – Establishes collateral to give the Seller recourse if the Buyer defaults on the Promissory Note.
*Deal-specific ancillary documentation may include a bill-of-sale, assignment and assumption agreement, and employment/contractor agreements to name a few (of many).
Benefits and Strategic Value for Buyers and Sellers
From the Buyer’s perspective, this financing structure reduces the immediate capital outlay and may enable acquisition without relying heavily on external debt. Additionally, it facilitates negotiations where valuation gaps exist, often serving as a mechanism for compromise. Finally, seller financing keeps the Seller financially invested in post-closing performance, ensuring smoother transitions.
From a Seller’s perspective, seller financing can command a higher purchase price, generate interest income, and defer capital gains tax under the installment method.
Legal Risks and How to Mitigate Them
Seller financing carries risk, especially for Sellers. Sellers must assess the Buyer’s experience to ensure that the Buyer has the capability to effectively operate the business such that the Buyer has the means to pay back the Seller.
Other mechanisms a Seller may utilize to reduce risk include:
- Down Payment Requirements – Upfront payments reduce exposure.
- Collateral and UCC Filings – Secure the Promissory Note with business assets and perfect the security interest.
- Acceleration Clauses – Accelerate the entire balance of a Promissory Note where a default occurs.
- Personal Guarantees – Require the Buyer to personally guarantee some portion of the seller-financed amount.
While creative structures like seller financing with no money down may appeal to Buyers, they carry heightened risk for Sellers.
All parties should consult counsel with M&A experience to tailor the structure to their specific transaction.
Alternatives and Comparisons
While seller Promissory Notes are flexible, they are not the only way to align the Buyer and Seller’s interest. Earn-outs and equity rollovers can also help bridge valuation gaps.
When choosing seller financing over other models, Buyers and Sellers must weigh repayment certainty, risk tolerance, and long-term ownership goals. Each alternative comes with its own legal considerations, collateralization standards, and tax impacts.
Why Legal Counsel Should Be Engaged Early
Engaging M&A counsel early in the process ensures all elements—from the Purchase Agreement and Promissory Note to earn-outs and tax implications—are structured to align with your business goals and risk profile.
At Founders Legal, we assist business owners, entrepreneurs, and private equity firms in structuring seller financing in M&A transactions to protect both short- and long-term business goals.