When structuring a business acquisition with SBA financing, you’ll often hear the term “standby note.” While it may sound technical, it plays a critical role in getting your loan approved—especially when seller financing is involved.
Understanding how standby notes work can help you structure a stronger deal and reduce your upfront cash requirement.
What Is a Standby Note?
A standby note is a type of seller financing agreement where the seller agrees to delay receiving payments for a specific period.
In simple terms:
The seller lends part of the purchase price but doesn’t get paid right away.
Full Standby vs. Partial Standby
There are two main types of standby notes in SBA transactions:
1. Full Standby
- No principal or interest payments for a defined period (typically 24 months)
- Can count toward the buyer’s equity injection requirement
This is the most powerful type for buyers.
2. Partial Standby
- Interest-only payments may be allowed
- Principal payments are deferred
- Usually does NOT count toward equity injection
Still useful, but less impactful for approval.
When Does the SBA Require a Standby Note?
The SBA doesn’t always require a standby note—but it becomes important in specific situations:
1. When Using Seller Financing as Equity Injection
If you want to use a seller note as part of your down payment, the SBA requires it to be on full standby.
Why?
Because the lender wants to ensure your cash isn’t being used to repay the seller immediately.
2. When the Deal Is Highly Leveraged
If the deal has:
- Low buyer cash injection
- High loan-to-value ratio
Lenders may require a standby note to reduce risk.
3. When Cash Flow Is Tight (DSCR Concerns)
If the business’s Debt Service Coverage Ratio (DSCR) is borderline, a standby note helps by:
- Reducing immediate debt obligations
- Improving cash flow in the early years
4. When the Seller Wants to Support the Deal
Sometimes, sellers voluntarily agree to standby terms to:
- Help the buyer secure financing
- Increase the likelihood of closing
This signals confidence in the business.
Example of a Standby Note in Action
Let’s say you’re buying a business for $1,000,000:
- Buyer cash: $70,000 (7%)
- Seller note (full standby): $30,000 (3%)
- SBA loan: $900,000 (90%)
The standby note helps you meet the 10% equity requirement without paying all of it upfront.
Why Lenders Care About Standby Notes
Standby notes reduce lender risk in several ways:
1. Improves Cash Flow
No payments in the early period = stronger financial stability.
2. Strengthens DSCR
Lower debt service improves your loan approval metrics.
3. Aligns Seller Interests
The seller has a financial stake in the business’s success after the sale.
Key SBA Guidelines for Standby Notes
To be accepted in SBA loans, standby notes must:
- Be formally documented and signed
- Clearly state the standby period
- Be subordinate to the SBA loan
- Be approved by the lender
Your lender will review the terms carefully before approval.
Common Mistakes to Avoid
1. Assuming All Seller Notes Qualify
Only full standby notes count toward equity injection.
2. Poor Documentation
Missing or unclear terms can delay your loan process.
3. Overusing Seller Financing
Too much reliance on seller notes can raise red flags.