The buyer is demanding that we carry a seller note for thirty percent of the purchase price but is refusing to pay market interest on it, claiming that our willingness to accept a zero-percent note is proof of our confidence in the company's future. How do we negotiate a fair interest rate and structure the note to protect our risk?

Question

Tyler Smith · Accepted Answer

Do not fall for the buyer's emotional leverage. Carrying a seller note means you are acting as a junior lender, and lenders get paid for risk. A zero-percent interest rate is not a sign of confidence, it is a free loan that devalues your hard work. Under the market approach of valuation, you must receive competitive compensation for the risk of leaving your capital in the business. If the buyer refuses to pay a market interest rate, the IRS will step in anyway. Under Section 1274 of the Internal Revenue Code, the IRS uses the Applicable Federal Rate to impute interest on seller-financed deals. This means you will be taxed as if you received interest income, even if the buyer paid you zero. You must explain this reality to the buyer and insist on a rate that at least matches or exceeds the current prime rate. To structure the note safely, tie the interest rate to the risk profile of the transaction. If your note is fully subordinated to a senior bank lender, demand a higher interest rate, typically in the range of eight to twelve percent, to reflect your junior position. Additionally, build protective covenants into the note. These covenants should include acceleration clauses that make the entire balance due immediately if the buyer sells the company, defaults on senior debt, or violates key financial ratios. Protect your position by treating the seller note as a professional financial instrument, not a handshake agreement.