Forgivable seller note best practices

June 25, 2024

by a searcher from New York University - Leonard N. Stern School of Business in Grand Rapids, MI, USA

What are the most common ways seller notes are made forgivable?

Examples I've come across:

If revenue is less than $3mm, seller note balance and all interest are void and forgiven reducing the note value to $0 and eliminating the debt obligation fully.

If DSCR falls below 1.5 in Y1, reduce seller note by $500k. If DSCR falls below 1.5 in Y2, reduce seller note by $500k.

I know one size doesn't fit all, so I'm asking for collective wisdom on what has worked in your deals.

All thoughts appreciated.

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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

We have seen a lot of forgivable seller notes in transactions lately. From my experience there is not one set way to structure the forgivable note. There are a few things you need to keep in mind though. First, the structure of the seller note obviously has to work for both you and the seller. Most sellers want the note structured so there is a high chance they can get paid so long as performance for the company does not change or future performance continues based on past performance. Secondly, however you structure that seller note it has to still work with the financing you are getting. Especially if you are using an SBA 7A loan, if it is in repayment from day 1 most SBA lenders are going to look at historical cash flow and not some sort of trigger for that seller note getting paid. Aside from that we have seen the following structures:

1) The seller note only gets paid if revenues and/or EBITDA exceeds a certain level. If it does not the payment either gets deferred or gets forgiven. Often times we see a formula for how much is forgiven based on how much EBITDA is missed by. Example: If EBITDA is 15% below the target, 30% of the seller note payment for that year is forgiven.

2) We have also seen it where the seller note is on standby and balloons out at a later date. So there is a future calculation of what is to be paid. This provides protection for the buyer and lender as there are no payments that need to be made in the interim period or maybe interest only payments.

3) We have seen buyers put covenants in place where they only pay the seller note if the senior DSCR is above a certain level and then they only make the payment based on what cash flow is available to do so. In these cases, either part of the note is forgiven each year or part of the note rolls over for so many years.

4) For growing companies, we have seen seller notes based on future projected earnings (not historical earnings). In these cases the note is only payable if that future level of earnings is reached, and usually there are benchmarks or percentages dictating what portion if forgivable or rolled if those benchmarks are not hit.

In all forgivable seller notes there is usually a time period in which the testing takes place, a defined structure for the testing that often includes a third party accounting firm that has to do the test, a maximum that can be earned (the note amount), a maximum roll-over or note period for which metrics can be hit, and some sort of formula for what can be forgiven. I hope this helps. I would be more than happy to jump on a call to discuss options in more detail, including for a specific transaction. You can reach me here or directly at redacted Good luck finding the right note structure for you.

Reply by a professional
from University of Michigan in Detroit, MI, USA

I don't have a lot to add to ^redacted‌'s reply (as usual!). But I will add the following. First, we only tend to see forgivable seller notes in SBA financed deals. In non-SBA deals, the parties typically negotiate an earnout (the SBA doesn't allow earnouts). Second, an SBA-compliant forgivable seller note must be based on historic (not forward looking) targets. And third, the seller normally pushes for a metric that cannot be fudged by accounting. E.g., revenue rather than net income.

As for the tax issue raised by ^redacted‌, forgivable seller notes are normally treated as reductions to the purchase price (rather than debt forgiveness). As such, forgiving the seller note will affect the cost basis of the assets. But, on the plus side, buyer will not incur taxable income on the amount forgiven. There are other posts dedicated to this topic.

Let me know if you want to jump on a call to discuss in more detail. You can reach me here or directly at redacted

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