How does a paying seller note affect SBA debt service coverage?
Short answer
It counts in full. A seller note not on full standby is limited by the business valuation and must be covered by debt service coverage. An interest-only note is tested on an amortization of no more than 10 years. Source: SOP 50 10 8.1, App. 15, Paras. A and C.2.b.
A paying seller note counts in full against your coverage. SOP 50 10 8.1, Appendix 15, Para. A, allows seller debt that is not on full standby, but it counts differently from equity.
How the note is treated
- It counts toward total debt on the deal, which is limited to the business valuation amount.
- Debt service coverage must support it.
- Coverage is 1.25:1 for an Initial Acquisition or Owner Buyout, and 1.15:1 for a Business Expansion (Para. C.2.b).
Interest-only notes get amortized anyway
Some acquisition debt outside full standby is interest-only. For that debt, the lender must apply an amortizationPaying a loan down on a schedule, so each payment covers interest and part of the balance. Full definition of no more than 10 years when testing coverage. Para. C.2.b gives the reason: the business must be able to service all debt tied to the acquisition. Lines of creditA credit limit you can draw on, repay and draw on again. are excluded from this test.
A worked example
A seller carries a $300,000 interest-only note. Tested on a 10-year amortization, principal alone is $30,000 a year. At 1.25:1 coverage, that takes $37,500 of annual cash flow before any interest.
What you give up
A paying note cannot satisfy the equity requirement. You need the full injection from other sources.
Lenders decide whether to accept seller payments and on what terms. Ask about subordination terms early, because policies vary.
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