Your buyer will want the right to offset your seller note.

A broad right of setoff lets the buyer stop paying your seller note and apply the withheld installments to an indemnification claim it asserts. No judgment, no escrow agent, no consent from you. Your note becomes the buyer’s private escrow, and you become the plaintiff. Narrow the trigger in the letter of intent, before price is agreed.

What is a right of setoff in a seller note?

A right of setoff is a term, usually sitting in the promissory note and mirrored in the purchase agreement, that permits the buyer to reduce or suspend payments to you and apply the withheld money against a claim it says it has against you. The claim is almost always indemnification, and the buyer decides when to use it.

The rule is simple. Whoever holds the money when a dispute starts does not have to sue. A broad setoff clause moves the money to the buyer’s side of the table, and the burden of suing with it.

The application is equally simple. The buyer finds a customer that did not renew, a payroll tax assessment for a pre-closing quarter, or a warranty claim on pre-closing work. It sends a notice, stops the next four payments, and calls the balance an offset. You are out of pocket and carry the burden of proof. The clause decides whether your deferred price is money or an argument.

Can the buyer stop paying my seller note because it has a claim against me?

Whether the buyer can lawfully stop paying a seller note turns on the words in the note, not on the merits of its claim. A note with a broad setoff right allows withholding on a good-faith assertion. A note saying the payment obligation is absolute and unconditional, without setoff, deduction or counterclaim, does not.

Waiver language is strong, not bulletproof. Courts generally enforce an absolute and unconditional payment clause, but that turns on the governing state’s law, and a defense such as fraud in the inducement often survives words written to waive defenses.

There is a practical point underneath the legal one. A buyer who wants to stop paying often will, permitted or not. The drafting decides what happens next. If the note forbids setoff and the buyer withholds anyway, it is in breach; once your written default notice goes out and any cure period expires, you can accelerate, provided the note contains an acceleration clause and no subordination or standby agreement suspends that remedy. If the note permits setoff, the buyer is exercising a contract right, and the only argument left is the merits of its claim.

Same money. Opposite posture.

How do I narrow the buyer’s right of setoff?

Narrowing a right of setoff means limiting it to claims finally determined by a court or arbitrator, or agreed by you in writing, and subjecting it to every limit that already constrains indemnification: the basket, the cap, the survival periods, the exclusions. A buyer refusing that should accept a neutral escrow of the disputed amount instead.

I read the setoff clause and the indemnification article together before I read the interest rate, because those two provisions decide whether the note is money.

Expect resistance. First drafts at this size open with setoff on a good-faith assertion, and many of these sales close with no escrow at all, making the note the buyer’s only recourse.

An asserted claim is not a determined claim. Terms worth fighting for:

• Escrow first, neutral home for disputed cash. Any escrow is exhausted first, and anything withheld before determination sits with an escrow agent.
• Interest keeps running. At the note rate, and at the default rate if the buyer loses, so far as that rate is enforceable.
• A deadline to sue, and fee shifting. The buyer files within a fixed period or releases the money with interest, and the loser pays costs.
• Applied to the back end. Permitted setoff reduces the final payments, not the current ones, so your cash flow survives.

A note that is subordinated, unsecured, guaranteed by nobody and freely offsettable is not consideration. It is a discount to the price, written in a font that looks like payment.

If the deal already has an escrow or holdback, is setoff double security?

An escrow or holdback and a right of setoff cover the same indemnification obligations, so a buyer holding both is protected twice for one risk. The escrow was priced into the deal; the setoff right was not. Coordination language fixes it: escrow is the exclusive source until exhausted, and every dollar set off counts against the same cap.

Watch sequencing in the purchase agreement, not only in the note. Buyers put an exclusive remedy provision in the indemnification article, then add a setoff right in the note. Where the two conflict, say which controls.

Watch the survival tail. If the escrow releases at twelve or eighteen months but the note runs three to five years, an uncoordinated setoff right extends your exposure to maturity. Tie setoff to the same survival periods, with written claim notice before they expire.

What notice, cure and acceleration terms should the note contain?

A seller note should require written notice of any default and a short cure period before remedies run, and should state plainly what happens next: acceleration of the entire unpaid balance, interest at a stated default rate, and recovery of collection costs including attorneys’ fees. Without an acceleration clause, you collect one missed installment at a time.

Reasonable structure at this size: a payment default gets a short cure period measured in business days, a covenant default longer, often thirty days, because covenant breaches are fixable. Notice goes to a named person at a named address, with email as a backstop.

Give the buyer one more discipline: a setoff notice must state the facts, the section relied on, and the amount claimed. Vague notices stretch disputes. A content requirement forces the buyer to commit to a theory while records are fresh.

If the buyer is borrowing from a bank or using an SBA-guaranteed loan, expect the lender to require your note to stand behind its loan under a subordination or standby agreement limiting when you can be paid, accelerate or sue. In SBA 7(a) acquisition lending those requirements sit in the agency’s operating procedure: a seller note credited toward the buyer’s required equity injection must be on full standby for the life of the SBA loan, meaning no payments to you at all. The procedure is reissued periodically, so confirm the version governing this loan.

Agency: U.S. Small Business Administration, SOP 50 10 8 (effective June 1, 2025), superseded by SOP 50 10 8.1 (effective October 1, 2026).

Should the person behind the buying entity sign a personal guaranty?

The buying entity in most private company sales is newly formed and owns nothing except the business it just bought from you. If that business declines, the entity’s only asset declines with it, and an unguaranteed note is worth whatever the entity is worth on the day you sue. A guaranty makes the note collectible.

Ask for a guaranty of payment rather than collection, so you need not exhaust remedies against the entity first. Ask the guarantor to waive the usual suretyship defenses, so amendments and extensions do not release the guaranty by accident; most states enforce those waivers, but only where the language is specific. Cap the guaranty, if at all, at a dollar figure rather than a percentage of something that can shrink.

I ask for the guarantor’s personal financial statement before I agree to any guaranty language, because a guaranty from someone with no assets is a signature, not security.

Two realities to price in. A private equity or search-fund buyer will often refuse outright, and the acquisition lender may restrict guaranties competing with its own. Neither is a reason to skip the ask. If the answer is no, shorten the note, increase the cash at closing, or tighten the setoff and default terms.

What information rights belong in the seller note?

Information rights are the covenants that let you see the buyer’s trouble before it becomes your missed payment. Without them, the first news you get is the default itself, and by then the cash is gone. At this size the package is periodic statements, notice of bad events, and a limit on distributions.

• Quarterly internally prepared statements, and annual statements after year end. Audited statements are not a realistic ask at this size.
• Prompt written notice of any default or forbearance under the senior loan.
• Written notice of material litigation, tax assessments, or loss of a major customer.
• No dividends, distributions or owner bonuses above a stated level while any payment is late.
• No additional debt senior to your note beyond the facility disclosed at closing, without your written consent.
• Repayment in full on a sale of the business or its assets, from the proceeds, after the senior lender is paid.

Assume the senior lender trims this list; the consent right over new senior debt and the payoff on a resale are what its subordination agreement is likeliest to cut back. Ask anyway. A buyer who resells in two years should not keep paying you in installments while a new owner runs it.

What interest rate does the seller note need so the IRS does not recast my principal?

A seller note must carry adequate stated interest, measured against the applicable federal rate, or the tax code will treat part of what the note calls principal as interest instead. Section 1274 governs most debt instruments issued for property, and section 483 reaches certain deferred-payment sales outside section 1274. The rates are published monthly by the IRS.

Law: 26 U.S.C. 1274; 26 U.S.C. 1274(d); 26 U.S.C. 483; 26 C.F.R. 1.483-1; 26 C.F.R. 1.483-2. Stated as of September 2026.

The consequence is the part owners miss. Recharacterization does not change the total you receive; it changes the character and sometimes the timing. Amounts recast as interest are ordinary income rather than gain, and under section 1274 the recast amount is original issue discount, which accrues over the life of the note. Accrual can mean reporting interest income before the cash reaches you.

The fix costs little. State the rate in the note itself, at or above the rate the statute tests against for that term. The test rate is not simply this month’s number: under section 1274(d)(2), a sale under a binding written contract uses the lowest applicable federal rate in effect in the three-month period ending with the month of that contract, and the rate varies with the length of the note. Confirm the figure with your accountant for the month of signing.

Two related points, each with its own article. Taking a note puts you on the installment method under section 453 by default for the gain that qualifies, reported as payments come in unless you elect out under section 453(d); dealer dispositions and inventory of personal property are excluded by section 453(b)(2). Recapture does not wait. Under section 453(i) it is taxed in the year of sale though the cash arrives over years, so run that number before agreeing to a small cash-at-closing figure.

Law: 26 U.S.C. 1274(d)(2); 26 C.F.R. 1.1274-4; 26 U.S.C. 453; 26 U.S.C. 453(b)(2); 26 U.S.C. 453(d); 26 U.S.C. 453(i).

The interest rate on a seller note is the easiest term in the document to get right and the most expensive one to leave blank.

What should I do before I sign the letter of intent?

The letter of intent is the only moment when the note’s terms and the note’s number are negotiated together. Once price is agreed, setoff, security, guaranties and default terms get treated as paperwork, and every one of them is a discount to that agreed price. Put the terms in the letter.

Concrete first steps:

• Write the note into the letter of intent: amount, rate, amortization, maturity, guaranty, and one sentence limiting setoff to determined or agreed claims.
• Ask, in writing, who signs the note and whether that entity owns anything besides the acquired business.
• Ask whether the buyer is using acquisition financing, and which lender, because that shapes what your note can say.
• Ask your accountant for the rate for the expected term, and the recapture number payable in the year of sale.
• Decide what portion of the price you will put at risk on the buyer’s performance, and price it as risk, not payment.
• Read the setoff clause, the indemnification article and any escrow agreement in one sitting. One mechanism, three places.

A seller note is not a promise to pay. It is a set of conditions under which you may be paid. Negotiate the conditions while the buyer still wants the deal.