Seller Note or Earnout? What an SBA Lender Actually Does With Each

This post is for informational purposes only. I am not an attorney or your accountant, and every transaction is different. Consult your own advisors for your specific situation. SBA program parameters referenced here are current as of August 4, 2026 and do change.

I keep having the same conversation, and it usually arrives about three weeks after the letter of intent is signed. The buyer calls and tells me the seller has refused to put a note on full standby. Somebody in the room, often the seller's broker and occasionally the buyer's own attorney, has suggested an earnout instead. Everyone seems relieved. The deal feels saved.

Then I have to explain that from a lending perspective those two structures are not variations on a theme. They are close to opposites. One of them can reduce the cash you need to bring to closing. The other one cannot, and in fact depending on how it is worded as an earn-out, it likely makes your deal completely ineligible for SBA financing.

We have reviewed 1,500 deals over the past three years, representing $5.3 billion in volume. Roughly 35% of the acquisitions in our current pipeline involve seller financing of some kind, and about 55% of those seller notes required restructuring before a lender would count them the way the buyer assumed they would be counted. Approximately 12% of the deals we see die at this exact conversation. Not at underwriting. Not at the appraisal. Three weeks after the LOI, when someone finally explains how the SBA deals with earn-outs.

Let me try to explain.

These terms get used loosely in deal conversations, and the looseness is where the trouble starts.

The distinction that matters is that the business does not have to pay on the debt if it is on standby, which means the SBA allows it to act as equity or to not get counted against the historical cash flow.

A seller note on full standby is a known quantity. The lender knows the amount, knows the term, and knows nothing is required to be paid during that standby term. That certainty is what lets the lender treat it as equity.

An earnout is the opposite. The amount is a range, the timing is conditional, and the payment comes out of operating cash flow at precisely the moment the business is supposed to be proving it can carry the new debt. The SBA wants assurances that they know the exact payment amount in advance for all seller debt and that there will not be any discretionary payments in the future that could negatively impact cash flow.

Under the current program parameters, an SBA acquisition requires a minimum 10% equity injection. That can drop to 5% when a qualifying seller note is on full standby for the life of the SBA 7A loan. The portion of a seller note that counts toward equity injection is capped at 5% of total project cost.

It is important to note what that means in practice. On a $2.5 million acquisition, which is close to our average deal size, the difference between a 10% injection and a 5% injection is $125,000 of the buyer's own cash. That is not a rounding difference. For most first time acquirers that is the difference between doing the deal and not doing the deal.

That being said, a seller note above the 5% threshold is not wasted. It still reduces the size of the bank loan, which improves your coverage ratio. It just does not earn equity injection credit for the portion above the cap, and any portion that is not on full standby gets counted as debt. The program parameters live in the SBA SOP 50 10 8.

Please keep in mind in order for the seller note to count as equity it must be on standby for the life of the SBA 7A loan. If you have a deal with real estate in it and a 25-year loan term, that means that seller note counting towards a portion of your equity would need to be on standby for 25 years. Often sellers will not go for that long of a standby note, so it is something to be aware of up front.

The SBA does not allow an earn-out based on Policy. There are no exceptions to that rule, and an earn-out will disqualify your loan from SBA financing.

However, there is another path you can take. If you create a seller note with forgiveness in it, and then if future metrics are not hit a portion of the loan gets forgiven, that does work in the SBA financing world. There are a few things you need to keep in mind when structuring a forgivable seller note in lieu of using an earn-out.

Structuring a forgivable seller note

Overall there is a lot of flexibility in how you create a forgivable seller note. The key is to be sure it is SBA compliant and it works with the available cash flow.

One thing we often hear from lenders is that a forgivable seller note has to be based on a metric the business has hit historically. We have submitted two loans directly to the SBA for approval where the forgivable seller note was based on a metric not hit before. In one case it was based on the addition of new customers that had been bid on, so new revenue that was not in existence prior. The second was based on higher EBITDA than had been historically reported. In both cases the SBA approved the forgivable seller note language. Even though the SBA does not approve earn-outs, it does not appear that language applies to a forgivable seller note where the parameters of that seller note ensure the cash flow will be there to service that seller note when it needs to be repaid.

Lastly, most lenders do not want the forgivable seller note set to amortize quicker than the SBA debt. If the seller does not want to wait the 10-year loan term to get repaid, then what you can do is have a 10-year amortization on the seller note but a balloon payment at year 4 or 5. Under that scenario all remaining principal and interest comes due at the end of the 4 or 5 year term. You can then refinance the debt or with lender approval, pay off the debt if you have the cash to do so.

I have to volunteer my conflict of interest here, as I always do. CLX earns a success fee when deals close. I have a financial incentive to encourage you to move forward. I am naming that so you can weigh what follows accordingly.

The reason this goes wrong is three fold.

First, the hardest truth. If your seller will not go on full standby for the life of the SBA 7A loan, then there is no other way for you to get an SBA loan with less than 10% down. You will need to come up with the full 10% down payment.

Secondarily, the strategic play. Have the standby conversation before the LOI, not after. In our pipeline, roughly 60% of sellers who initially resisted full standby agreed to it once someone explained what it actually is. Most refusals are not refusals. They are a reaction to an unfamiliar term explained badly by someone who did not understand it either. The explanation that works is short: you are not forgiving the money, you are delaying getting those funds, and the reason you are waiting is that it is what makes the buyer financeable, which is what gets you paid at all.

Lastly, the reassurance. Earnouts are not allowed under the SBA 7A rules. However, you can get creative with a forgivable seller note to solve the same issue you were attempting to resolve with an earn-out. In fact, I would argue a forgivable seller note gives you more power because you have a set payment amount and a set term.

The good news is that the conversation is usually winnable, provided you have it early and someone in the room can explain the mechanics in plain language.

That figure is not a negotiation trick. It is what happens when the seller finally understands they are waiting for the money rather than giving it up.

A seller note on full standby and a forgivable seller note are both legitimate tools, and I have used both. They are not substitutes for one another. The standby note is the only one of the two that reduces the cash you have to bring to closing, and it does so because the lender can see exactly what is not being paid and exactly when. Although earn-outs are not allowed by the SBA rules, a forgivable seller note can be used to solve most of what the earn-out was targeted to solve, and can make the cash flow of a higher valuation on a deal work while still providing protections for the buyer.

If you take one thing from this, take the sequence. Ask about standby before you sign the LOI, understand what your answer costs you in cash, and reach for a forgivable seller note only when the disagreement is genuinely about value. Get that order right and this conversation never becomes the reason your deal dies.

I hope this helps.

If you have questions about seller note and forgivable seller note structures, we would be happy to help you find the right answer for your specific situation. You can reach me directly at brad@commerciallendingx.com or by phone at 630 988 4852.

Brad Hettich, President
Commercial Lending X