A seller note makes you a creditor after closing; an earnout makes part of the price dependent on agreed future conditions. Neither is equivalent to cash received at closing. Evaluate the documents, counterparty and downside case before using deferred consideration to bridge a price gap.
In this guide
Understand the proposed instrument
A note generally describes a repayment obligation with terms such as principal, interest, payment schedule and maturity. An earnout ties additional consideration to a defined outcome. Rollover equity is a separate investment. Ask the buyer to identify each component clearly.
Do not let a proposal bundle them into one future payment estimate. Your rights, tax treatment and risk can differ across the components.
Separate the promise to pay from the ability to pay
Scroll sideways to compare columns. You can also focus the table and use the arrow keys.
| Component | What to examine | A downside to model |
|---|---|---|
| Closing cash | Actual funds, payoffs, escrow and other closing deductions. | Less immediately available cash than the headline amount suggests. |
| Seller note | Borrower, repayment schedule, maturity, reporting and creditor rights. | Missed payments, a refinancing shortfall or insufficient collateral. |
| Earnout | Metric, permitted operating changes, records, period and disputes. | No payment even though the buyer continues operating the wash. |
| Retained equity | Entity, ownership rights, distributions, dilution and exit provisions. | An illiquid investment with no scheduled cash return. |
Keep the note's contractual balance separate from your planning estimate of money actually collected. Likewise, an earnout cap is the most that could become payable under its formula, not a receivable to treat as cash today. If the seller relies on these amounts for retirement spending, test that household plan with the relevant adviser before accepting the structure.
For a wash, ask how membership collections, retail weather swings, equipment downtime and the proposed rent affect the repayment case. A forecast based on peak-season revenue while assuming average costs can conceal a shortfall. Request a monthly view when the annual total hides timing pressure.
Review the repayment case
Ask how the buyer expects the wash to support operating costs, capital needs, senior debt and the seller note. Examine a weaker operating case, not only the acquisition model’s expected outcome.
Have counsel review collateral, guarantees, lien priority, subordination, payment restrictions, reporting rights, default remedies and enforcement costs. A secured note can still produce a loss if the collateral is insufficient or senior claims consume its value.
Read the payment schedule through the maturity date
Illustrative arithmetic: a $300,000 note at 8% simple annual interest, paid monthly on an interest-only basis, produces a $2,000 monthly interest payment and leaves the full $300,000 principal due at maturity. This example assumes no fees, defaults, payment blocks, compounding or principal reduction. An amortizing note would produce a different schedule. The stated rate is an example, not a market quote or a recommended term.
If the buyer expects to refinance that final balance, ask what happens if refinancing is unavailable. If a senior lender can restrict payments, have counsel and the lender explain the actual arrangement before counting on the $2,000 monthly receipt. Ask whether interest continues to accrue during a payment block and how the final obligation changes.
Next consider a purely illustrative collateral shortfall: if net recoverable collateral is $500,000 and claims ahead of the seller consume $450,000, only $50,000 remains for a $300,000 seller claim before any further costs or claims. This is not a legal distribution analysis or an equipment appraisal. It explains why collateral value, priority and enforcement economics need separate review rather than relying on the word secured.
Coordinate with the buyer’s lender
If financing is involved, ask the lender to confirm how the proposed seller note fits the transaction. Standby, subordination and repayment restrictions can materially change the cash you receive and when you receive it.
SBA’s 7(a) program overview provides financing context, but program rules and the lender’s requirements must be checked for the actual transaction. Do not assume a percentage, standby period or approval based on a general example.
Reference for this section: SBA: 7(a) loans
Define an earnout that can be measured
Identify the metric, accounting policies, measurement period, access to records and dispute procedure. Ask who controls pricing, staffing, marketing, overhead allocations, capital spending and any integration that affects the metric.
Consider what happens if the buyer sells the business, closes a location, changes the brand or combines systems. A clear maximum amount does not resolve these questions. Counsel and the accountant should review the mechanics together.
Test the earnout formula and the timing of taxes
Illustrative earnout: suppose the documents provide 20% of defined annual revenue above $1 million, capped at $100,000. Defined revenue of $1.2 million produces $40,000; revenue at or below $1 million produces zero under this formula. A description such as membership growth bonus is insufficient to reproduce either result.
For a wash, resolve the treatment of prepaid plans, refunds, sales taxes, price changes, closed days and members moved to another location. If accounts migrate to the buyer's existing platform, identify the report that will preserve the agreed measure. Test a normal month, a system change and an early resale against the proposed formula with the accountant and lawyer.
IRS Publication 537 explains that an installment sale of a business must be considered asset by asset. Inventory does not qualify for installment reporting, and depreciation recapture income is reported in the year of sale even if no installment payment arrives that year. Interest and contingent payments also need separate tax analysis. Deferring payment therefore does not mean all tax is deferred.
Request a year-by-year cash and estimated-tax schedule before agreeing to terms. Keep that tax schedule separate from the buyer's repayment forecast: a sound calculation of a tax obligation does not establish the cash to pay it. Revisit both schedules when the price allocation, timing or consideration changes.
Reference for this section: IRS: Publication 537, Installment Sales
Model a downside
If a hypothetical $300,000 seller note stops paying, what cash and legal options would remain? If an earnout pays zero, does the guaranteed portion still meet your needs? These questions are more useful than treating every deferred dollar at face value in a proceeds estimate.
Compare the proposed structure with a lower cash offer and with waiting. There may be a sound reason to accept deferred consideration, but it should be a deliberate credit or investment decision.
Questions to resolve before agreement
- Who owes the money, and what supports the obligation?
- Which other creditors have priority?
- Can payments be suspended, offset or accelerated?
- What information will you receive after closing?
- What happens on a sale, default or business closure?
- How will taxes and your own cash needs be funded?
Have your tax adviser review payment timing under the applicable rules. Keep notes and earnouts separate in your offer comparison and update the proceeds view only when assumptions are understood.
Sources and scope
These references support the specific topics described below. Recorded source-check dates are shown where available. Our checklists and examples are educational analysis, not transaction or professional opinions.
- SBA: 7(a) loans
Program overview; eligibility and transaction financing require current lender review.
Source checked
- IRS: Publication 537, Installment Sales
Installment reporting, exceptions and depreciation recapture.
Source checked
This guide provides general education. Your documents, jurisdiction and circumstances determine the advice you need. Figures labelled illustrative are examples, not reported transactions or market benchmarks.