What does it mean for a seller note to be on full standby?

Standby is about payments, not about the debt existing. The seller note is real, it sits on the balance sheet, and the seller is a creditor. What standby does is stop money flowing to that creditor while the senior lender is being repaid.

Full standby versus partial standby

The document that creates it is a standby agreement, sometimes called a subordination and standby agreement, signed by the seller and the senior lender. Read it, because the terms vary and the seller usually signs it at closing with minimal review.

Standard provisions:

• No payments of any kind without the senior lender's written consent.
• The seller may not accelerate the note, sue on it, or exercise remedies.
• The seller's lien, if any, is subordinated to the senior lender's.
• Any payment received in breach is held in trust for the senior lender.
• The seller may not take additional collateral or guarantees.
• The standby survives changes to the senior loan, including amendments and extensions.

Why lenders want it

Cash flow. A note being paid is debt service; a note on standby is not. In a coverage calculation, moving 270,000 of seller paper onto full standby can be the difference between a deal that works and one that does not — see sizing an acquisition against cash flow.

There is also a signalling purpose. A seller who will accept full standby is a seller who believes the business will perform. A seller who insists on being paid from day one is telling you, and the lender, how confident they are.

Where an SBA-guaranteed loan is involved, seller debt can also interact with the buyer's required equity injection. The conditions have varied between revisions of the agency's standard operating procedures — typically turning on whether the note is on full standby for the term of the loan, and how much of the injection it may represent. Do not plan around a remembered version. Read the current SOP text with your lender before you structure the deal, and get the lender's written confirmation of how they will treat the note.

The accrual question, which is where the money is

• Interest accrues at 6 per cent, compounded annually. The balance at year ten is 268,627, payable as a balloon.
• Interest accrues simple. 150,000 plus 90,000 of interest — 240,000. A difference of 28,627 produced by one word in the note.
• No interest accrues. 150,000 at maturity.
• Interest accrues and is paid annually. Not full standby.

Now ask the obvious follow-up: where does 268,627 come from in year ten? Either from refinancing, from the business's accumulated cash, or from a sale. If the plan is "refinance it", that plan depends on credit conditions and business performance a decade out. A balloon that large deserves a sinking fund or a negotiated amortisation starting the moment the senior loan is paid.

If instead the note amortises over eight years after a two-year standby, the payment on 150,000 at 6 per cent is 1,971 a month — which is debt service the business has to carry from year three, and which should be in your model from the start.

What to negotiate, as the buyer

1. No compounding. Simple accrual, or no accrual. This is often conceded because sellers focus on the rate, not the compounding.
2. A defined end to the standby tied to the senior loan being repaid, with an amortisation schedule that starts then, rather than a lump sum.
3. A right of offset. If the seller's representations and warranties turn out to be wrong, you want to reduce the note rather than sue. Get the offset right written into the note itself.
4. Clarity on what happens if you refinance the senior debt. Does the standby continue against the new lender? Most standby agreements survive; make sure the seller understands this before closing rather than after.
5. No security, or clearly subordinated security. A seller with a lien can complicate future borrowing even when subordinated, because the UCC search shows the filing and the next lender wants it addressed.

What to check as the seller taking the note

You are lending the buyer a large sum, unsecured in practice, with no ability to enforce. Before agreeing:

• Understand that you cannot act on non-payment during the standby, whatever the note says, because the standby agreement overrides it.
• Get financial reporting rights — annual statements at minimum — written into the note.
• Understand the tax treatment of accrued but unpaid interest, which may be taxable before it is received. Ask your CPA specifically about this.
• Consider a personal guarantee from the buyer, if the senior lender permits it, and confirm in writing whether it does.

Whichever side you sit on, get the standby agreement in draft before the closing week. It is a short document that changes the economics of the deal more than the purchase price does.