A search fund buyer is purchasing our company with SBA debt and asking us to carry a ten percent seller note on full standby for two years. How do we structure this note and its equity pledge so we do not lose our principal if the sponsor defaults on the senior lender?

Question

Tyler Smith · Accepted Answer

A full standby seller note required by an SBA lender means you receive zero interest and zero principal payments for twenty-four months. If the new buyer struggles operationally, you stand last in line behind the senior bank. If they default, the bank liquidates the assets and wipes out your note completely.

To protect your capital when taking back SBA-subordinated paper, you must secure operational visibility and structural leverage outside the senior lender restriction.

First, secure a secondary pledge of equity. While the senior lender holds the primary lien on company assets, you can negotiate a pledge of the buyer holding company stock. If the buyer defaults on their obligations to you after the standby period, you have legal rights to initiate foreclosure on their ownership interest, subject to senior bank standstill limits.

Second, build information covenants into the seller note agreement. Require monthly financial delivery, including updated balance sheets, cash flow statements, and EOS Scorecard measurables. If revenue or cash reserves breach agreed thresholds, require a mandatory consultation right.

Third, negotiate automatic interest rate step-ups. If the buyer fails to pay off the note at maturity, the interest rate should jump by five hundred to eight hundred basis points, compounding monthly.

Finally, confirm whether the SBA standby allows interest to accrue. Structure the note so that unpaid interest compounds quarterly into principal during the two-year standby window. That protects the time value of your deferred proceeds while remaining compliant with SBA underwriting.