Deferred Payments in SBA-Backed Acquisitions

When buying a business using an SBA loan, deferred payments like seller notes can help bridge the gap between the loan amount and the purchase price. Seller notes allow the seller to accept part of the payment over time, reducing the buyer's upfront cash requirement. These arrangements can lower the buyer's down payment to as little as 5% of the purchase price, provided the seller note meets SBA requirements. However, seller notes must remain subordinate to the SBA loan and often require deferred or interest-only payments for a specific period.

Key points to know:

• Seller Notes & Equity Contribution: Seller notes can cover up to 50% of the required 10% equity injection, reducing the buyer's cash down payment.
• Standby Periods: Notes used for equity must stay on full standby (no payments allowed) for the entire SBA loan term, typically 10 years.
• Interest Rates: Seller notes typically carry 6–8% interest.
• Risks: Deferred payments can lead to high accrued interest or balloon payments, which may strain cash flow later.
• New 2025 SBA Rules: Stricter underwriting now requires verified tax returns for cash flow analysis and higher borrower credit scores.

While seller notes can make acquisitions more accessible, careful planning is crucial to avoid financial stress later. Aligning repayment schedules with cash flow projections and adhering to SBA guidelines is essential for a successful deal.

Using Seller Financing with an SBA Loan

SBA Lender Requirements for Deferred Payments

When it comes to seller note financing, SBA lenders enforce strict guidelines to protect their investments. One key requirement is the use of SBA Form 155, also known as the Standby Creditor Agreement. This document ensures that the seller's debt takes a backseat to the bank's claim on the borrower’s assets.

For seller notes that contribute to the 10% equity injection, they must remain on full standby - meaning no payments are allowed for the entire term of the SBA loan, which is typically 10 years. Additionally, seller notes can only account for up to 50% of the required equity. For instance, a buyer could contribute just 5% in cash if the seller note covers the other 5%.

"Seller debt may not be considered as part of the equity injection unless it is on full standby for the life of the SBA loan and it does not exceed half of the required equity injection." – Douglas Adams, VP of SBA Lending at Comerica Bank

Let’s break down the subordination rules and how interest-only periods work.

Subordination Rules and Interest-Only Periods

For seller notes that don’t count toward the equity injection, SBA lenders typically require a partial standby period of 24 to 36 months. During this time, no payments are permitted, which helps preserve cash flow while the business transitions and stabilizes. Once the standby period ends, the note can move into an interest-only payment phase for another 1 to 3 years before full principal and interest payments kick in.

Interest rates on seller financing are usually between 6% and 8%, reflecting the higher risk associated with subordinated debt. The Standby Creditor Agreement also mandates that payments on the seller note must stop if the borrower defaults on the SBA loan. Additionally, any liens tied to the seller note must remain secondary to the SBA lender’s liens.

Maximum Deferral Periods and Cash Flow Projections

The length of the deferral period depends on whether the seller note is being used to meet the equity injection requirement. If it qualifies as part of the 10% equity injection, the deferral must last the full term of the SBA loan - about 10 years. For non-equity seller notes, the deferral period is negotiable but typically ranges from 24 to 36 months.

Lenders rely on the Debt Service Coverage Ratio (DSCR) to evaluate these deferred payment structures. They usually require a DSCR between 1.25× and 1.50×, calculated from verified tax returns rather than seller-reported earnings. To ensure the business can handle debt payments once the deferral ends, lenders also assess whether it could sustain a 15% to 20% drop in EBITDA.

"DSCR below 1.25× = automatic decline - lenders calculate from tax returns, not seller claims." – Danielle Hunt from EBIT Community

Interest-Only vs. Full Payment Deferrals

The type of deferred payment structure - interest-only or full payment deferral - varies based on the business’s cash flow situation. Here’s a quick comparison:

Feature	Interest-Only Deferral	Full Payment Deferral (Full Standby)
Payment Status	Monthly interest paid; principal deferred	No principal or interest payments allowed
SBA Equity Credit	Does not count toward the 10% equity injection	Can count for up to 5% of the 10% equity requirement
Typical Duration	1–3 years before switching to full amortization	Life of the SBA loan (if used for equity) or 24+ months
Lender Preference	Used when cash flow is tight but sufficient for interest payments	Required when the business cannot meet DSCR with full debt

Given how detailed and negotiable Standby Creditor Agreements can be, it’s crucial that the promissory note aligns perfectly with SBA Form 155 to avoid any delays at closing.

2025 SBA SOP Updates and Their Impact on Deferred Payments

On June 1, 2025, the SBA rolled out SOP 50-10-8, introducing significant changes to how lenders assess deferred payment structures. One of the most notable updates is the removal of the "Do What You Do" underwriting framework. This policy, initially adopted in 2023, allowed lenders to apply their own commercial credit standards. However, it contributed to a $397 million deficit in the 7(a) loan program by FY2024, leading the SBA to revert to stricter, standardized underwriting requirements. These updates are reshaping the way deferred payments are evaluated across the board.

"The SBA officially eliminated the 'Do What You Do' underwriting framework... This approach led to a surge in defaults and a $397 million deficit in the 7(a) loan program by FY2024." – SBG Funding

Under the revised guidelines, lenders are now required to verify tax transcripts for all loans. This ensures cash flow calculations are based on official IRS-documented earnings, rather than relying on seller-reported figures. Additionally, the minimum Small Business Scoring Service (SBSS) score for 7(a) loans has been raised from 155 to 165, setting a higher standard for borrower creditworthiness.

Stricter Rules for Seller Notes

The 2025 updates also impose tighter regulations on seller notes used to meet the 10% equity injection requirement. Seller notes now must remain on full standby for the entire SBA loan term, which is typically 10 years.

Lenders are placing greater emphasis on historical tax returns when calculating Debt Service Coverage Ratios, moving away from seller-reported "Seller Discretionary Earnings" (SDE). Earnings adjustments, such as owner benefits or personal expenses, are no longer credited unless they are documented in tax filings. This shift results in more conservative financial projections and increases the likelihood of loan denials for deals relying on inflated earnings claims. These stricter standards establish a firmer baseline while still allowing for tailored evaluations in specific cases.

Flexibility in Deferral Structures

Despite the more rigorous baseline, lenders retain the ability to adjust deferral structures based on the borrower's financial strength and the specifics of the deal. For seller notes that don’t count toward the equity injection, lenders can still apply flexible terms to reflect the unique aspects of each transaction.

To minimize risk, lenders are stress-testing deals more rigorously. This includes evaluating whether the business can endure a 15% to 20% drop in EBITDA during the transition period. They are also incorporating a $100,000–$200,000 working capital cushion to address potential challenges like employee turnover or tighter supplier credit. This approach ensures deferral structures are customized to the circumstances of each acquisition, provided the borrower meets the SBA's core underwriting standards.

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Borrower Considerations and Risks

Benefits for Borrowers

Deferred payment structures offer a lifeline for buyers by providing immediate cash flow relief. By postponing seller note payments, buyers can maintain a working capital cushion of $100,000–$200,000, all while reducing their cash down payment to as little as 5% of the purchase price. This flexibility can be critical during the early days of ownership, especially when stabilizing operations, keeping key employees on board, or managing supplier relationships - areas that often face strain during a transition.

Financially, this approach works in the buyer's favor in several ways. For example, using a seller note on full standby significantly reduces the upfront cash needed, with the note covering up to 5% of the required 10% equity injection. Additionally, if the business's appraised value falls short of the purchase price, a deferred seller note can bridge that gap, sparing the buyer from having to inject more cash upfront.

"Keeping at least a small seller's note can make a lot of sense... This keeps the seller motivated to help you succeed as the new owner." – Adam Hoeksema, Co-founder, ProjectionHub

Beyond the numbers, deferred payments can align the interests of both buyer and seller. When part of the purchase price remains unpaid, the seller has a vested interest in ensuring the buyer’s success. This often translates into more thorough training, smoother customer introductions, and better operational handoffs. Some agreements even tie payment deferrals to revenue cycles, meaning payments only kick in after hitting specific growth benchmarks. However, while these benefits are compelling, they come with potential risks that buyers need to carefully evaluate.

Risks of Accrued Interest and Balloon Payments

While deferring payments can ease early cash flow pressures, it also introduces financial risks that could affect long-term stability. During interest-only or standby periods, interest continues to accrue on the seller note, typically at rates between 6% and 8%. If this interest compounds, the principal balance can grow significantly, leading to a steep increase in monthly payments once the deferral period ends. This sudden jump in debt service can put a strain on cash flow.

Balloon payments bring their own challenges. While they keep monthly payments low during the loan term, they create a looming refinancing cliff at maturity. If interest rates rise, business performance weakens, or lenders become less willing to finance, finding new funding to cover the balloon payment can be difficult. This liquidity crunch might force owners into costly refinancing terms or even asset sales. The problem becomes even more pronounced if the seller note’s amortization period is shorter than the SBA loan term, resulting in overlapping full payments on both loans - a scenario that can quickly drain working capital.

Deferral Feature	Advantage	Risk
Interest-Only Period	Provides moderate cash flow relief	Sharp increase in payments when principal kicks in; potential strain on debt service coverage ratio (DSCR)
Full Standby	Maximizes early capital preservation; counts toward equity	Higher overall interest costs; significant debt spike after the standby period ends
Balloon Payment	Keeps monthly payments low throughout the term	High refinancing risk at maturity; could lead to liquidity issues if refinancing options are limited

SBA loans require unlimited personal guarantees for owners with at least 20% equity, so poorly managing deferred payments can put personal assets at risk. To mitigate this, it’s critical to stress-test the financials against a 15–20% EBITDA decline before committing to any deferral structure. This ensures the business can absorb the financial hit when payments increase.

How to Structure Deferred Payments

Documentation and Justification Requirements

Getting approval for deferred payments starts with thorough documentation. The cornerstone of this process is SBA Form 155 (Standby Creditor Agreement), which formalizes the subordination of a seller note to the SBA loan. This form must explicitly state that payments on the seller note will halt if the borrower defaults on the primary SBA loan. To support this, include a promissory note and a security agreement that outline the standby terms - whether they are interest-only, full standby, or a hybrid arrangement. It’s also crucial to ensure all documentation aligns with the lender’s specific requirements.

When the seller note is used for the equity injection, it must remain on full standby for the life of the SBA loan and cannot exceed 50% of the equity contribution. Lenders carefully assess cash flow projections, requiring a Debt Service Coverage Ratio (DSCR) of at least 1.25× to 1.50× to ensure repayment feasibility.

"Structure determines survival, not purchase price. A $2M deal at 1.66× DSCR beats a $1.5M deal at 1.28× DSCR." – Danielle Hunt

To verify financial projections, lenders rely on official tax returns rather than seller-reported earnings. For more complex transactions, spending $5,000–$10,000 on a Quality of Earnings (QoE) report can be a wise investment. This report helps validate EBITDA adjustments and uncovers any hidden liabilities.

Deferral Period Limits and Extensions

Once the documentation is in order, the next step is determining appropriate deferral periods. The duration of the deferral period depends on whether the seller note is being used as equity. If it contributes to the 10% equity injection, it must remain on full standby for the entire term of the SBA loan - typically 10 years. For seller notes that aren’t used as equity, the standard standby period ranges from 24 to 36 months. This shorter timeline provides flexibility during the transition while allowing the seller to start receiving payments sooner.

If there’s a need to extend the deferral period beyond these typical limits, lenders will require strong justification. This includes detailed cash flow projections showing why additional time is necessary and how the business will sustain payments once they begin. Aligning the seller note’s amortization schedule with the SBA loan term is also critical to avoid early balloon payments.

Additionally, agreements can incorporate forgivable portions of the seller note, tied to achieving specific benchmarks like 90% revenue retention or retaining key staff. These forgivable terms must be based on measurable and verifiable metrics, such as payroll records or customer contracts, and will require lender approval before the deal closes.

Conclusion

Deferred payments through seller notes offer a practical way to reduce initial cash outlay and preserve working capital. For sellers, this arrangement not only provides tax deferral but also generates additional interest income, enhancing their overall returns. Plus, when a seller agrees to finance part of the deal, it sends a strong message about their confidence in the business's future viability.

That said, buyers need to ensure that the combined debt service remains manageable within the projected cash flow. A Debt Service Coverage Ratio (DSCR) between 1.25× and 1.50× is generally recommended, with stress tests accounting for a potential 15–20% drop in EBITDA.

Adhering to SBA guidelines is equally crucial. Use SBA Form 155 to confirm full standby for equity-related seller notes, and avoid earn-outs, as they’re not allowed. Aligning the seller note's repayment schedule with the SBA loan term is key to preventing balloon payments down the line.

As Walker Deibel wisely points out:

"The real beneficiary of a seller note is not the seller... It's not the buyer, either... The real beneficiary is the bank".

This highlights the importance of proper subordination and standby agreements to protect lender interests while ensuring a balanced transaction.

To bridge financing gaps effectively, buyers should focus on detailed planning, cash flow analysis, and seeking early input from legal and lending experts. Maintaining a liquidity cushion - typically between $50,000 and $150,000 - can help navigate any transition-related challenges. By adhering to SBA requirements and building solid financial projections, buyers can set the stage for a smoother and more secure acquisition process.

FAQs

How can seller notes help reduce the buyer's upfront cash requirement in SBA-backed acquisitions?

When a seller offers a seller note, they help finance part of the buyer's required equity injection - often up to 50% of the typical 10% equity requirement. In practical terms, this means the buyer might only need to provide 5% in cash, while the seller note takes care of the rest. This arrangement reduces the buyer's initial cash commitment, making it more manageable to fund the purchase.

What are the risks of deferred payments in SBA-backed acquisitions, and how can they affect cash flow?

Deferred payments, such as seller notes, are a common feature in SBA-backed acquisitions, allowing buyers to delay part of the purchase price. While this can ease the initial financial burden, it often leads to cash flow challenges. One key issue is meeting the lender's required minimum debt service coverage ratio (DSCR) of 1.25×. Falling short of this threshold can result in loan denial or trigger strict cash-sweep provisions, which redirect any extra cash from the business toward repaying the loan. This limits the funds available for day-to-day operations.

Another complication is that seller notes are typically subordinated to the SBA loan. This means buyers must prioritize repaying the senior debt while still managing the deferred payments. Balancing these obligations can be especially tough early on, when the business might still be finding its footing. Some payment arrangements include interest-only periods to temporarily ease cash flow pressures, but these can lead to "payment shocks" when principal payments kick in.

To navigate these challenges, buyers need to carefully model their cash flow. A thorough plan ensures they can handle these layered payment obligations without putting the business’s financial stability at risk.

How do the 2025 SBA rules impact the use of seller notes in business acquisitions?

The 2025 updates to the SBA policy (SOP 50 10 8) have introduced more flexibility for buyers using seller notes to meet equity requirements in SBA-backed acquisitions. Under the new rules, buyers can now structure deals with just 5% cash down, 5% seller note, and the remaining 90% financed through an SBA 7(a) loan. This adjustment allows buyers to conserve cash while still meeting the SBA’s equity injection standards.

That said, lenders are now enforcing stricter documentation to ensure seller notes comply with SBA guidelines. These notes must be properly documented, subordinated to the SBA loan, and adhere to specific rules on interest rates and amortization. Borrowers should carefully negotiate terms like interest-only periods and repayment schedules to ensure they align with both SBA requirements and lender expectations.

Platforms like Clearly Acquired can assist buyers and sellers in structuring compliant seller notes, managing documentation, and navigating these updated rules for a smoother closing process.