If we agree to provide seller financing to help get our deal done, how do we structure the interest rate and payment terms in the LOI to protect the real purchasing power of our note against inflation over a long term?

Question

Tyler Smith · Accepted Answer

Accepting a fixed-rate seller note during inflationary times is a quiet way to lose money. If you hold a five-year note at a low, fixed interest rate while inflation runs hot, the real value of your principal payments shrinks every year.

To protect your purchasing power, you should negotiate a floating interest rate in the LOI. Tie the interest rate of your seller note to a widely recognized benchmark, such as the prime rate or the Secured Overnight Financing Rate, plus a specified spread. This ensures your yield adjusts upward automatically if interest rates rise to combat inflation.

Additionally, structure the note with a shorter maturity and a balloon payment, rather than a long-term amortization schedule. For example, use a ten-year amortization schedule to keep the buyer's monthly payments manageable, but require a full balloon payment at the end of year three or four. This limits your exposure to inflation and forces the buyer to refinance you out of the capital structure sooner.

You can also negotiate a principal adjustment clause tied to the Consumer Price Index, where the outstanding principal balance of the note increases annually to match inflation. Whichever mechanism you choose, establish these terms directly in the LOI before exclusivity lock-up.