Seller-financing instruments.

The forms-of-consideration page covered the consideration the seller takes. This page is the legal-instrument layer that converts deferred or contingent consideration into enforceable seller paper. The three instruments — promissory note, subordination architecture, stock pledge — work as a system. A weak link in any one of them undermines the whole structure. This Explainer covers what each does and what to negotiate for.

The debt instrument itself.

The promissory note is the foundational document — the buyer's written promise to pay the seller a defined amount on a defined schedule, with defined consequences for non-payment. The boilerplate version of the document is rarely the right version. The provisions that separate a defensible note from a hope note:

• Interest rate. AFR (Applicable Federal Rate) compliance is the floor — below AFR, the IRS imputes interest and creates phantom income. Above AFR, the seller earns real yield on the deferred portion.
• Acceleration clause. Specific events trigger the right to demand immediate full payment — missed payment, financial-covenant breach, bankruptcy filing, sale of acquired assets. The list matters; default boilerplate is often too narrow.
• Cure period. Standard 30 days to cure missed payment before acceleration; shorter for material breaches. Too-long cure periods give the buyer extended grace at the seller's expense.
• Default rate. Interest rate that applies after default — typically 2–4 points above the standard rate. Compensates the seller for the elevated risk and creates pressure on the buyer to cure quickly.
• Cross-default. A breach of any other major obligation (senior debt covenant, lease, employment agreement) triggers default under the seller note. Aligns the seller's note with the broader risk picture.

Payment priority in practice.

Almost every seller note in modern agency M&A is subordinated to senior bank debt. The subordination agreement is where the practical reality of payment priority gets defined. Three concepts determine whether the subordination is workable or punitive:

The hope note is what happens when subordination is accepted without specific payment-blockage and standstill protections. The seller has a promissory note that technically exists but is functionally unenforceable for as long as senior debt is unhappy — and senior debt can be unhappy for a long time.

Security perfection.

The stock pledge agreement is the security instrument that gives the seller note teeth. Without it, the note is unsecured — collectible only through litigation if the buyer defaults. With it, the seller has direct recourse to the equity of the acquired agency entity. Done correctly, the seller can effectively take the agency back if the buyer fails to pay.

The mechanics that perfect the security:

• UCC-1 filing. Filed with the appropriate Secretary of State; gives the seller's security interest priority over unsecured creditors and notice to subsequent secured parties. Should be filed promptly at close.
• Stock power deposit. Pre-signed stock power transferring the pledged shares back to the seller, held in escrow with a neutral third party. Allows immediate transfer of equity upon default without further buyer cooperation.
• Three-party custody arrangement. The pledged stock certificates themselves are held by a neutral third party (escrow agent or attorney), not the buyer. Eliminates the risk of buyer-side delay or interference at the moment of default.
• Anti-dilution covenants. Restrictions on the buyer's ability to issue additional equity, restructure the entity, or move assets to other entities — all moves that could dilute the value of the pledged collateral.
• Payment-waterfall enforcement. Documented order in which proceeds from the pledged collateral are applied if the seller forecloses — typically: collection costs, accrued interest, principal, in that order.

The installment sale election.

One material benefit of seller financing is the IRC §453 installment-sale election — the seller pays capital-gains tax only on the portion of proceeds actually received in each tax year, not on the full nominal note value at close. The structural effect: tax deferral that can be meaningful in dollar terms, especially for sellers in higher state-tax jurisdictions.

The election is automatic for qualifying seller notes (with limited exceptions for inventory and certain related-party rules) but the deal has to be structured to qualify. Key conditions:

• Genuine debt instrument. The note must be a real promissory note with arm's-length terms, not a disguised equity arrangement.
• Not a publicly traded buyer note. Notes from publicly traded acquirers don't qualify for installment treatment.
• Compliance with the AFR. Below-AFR notes trigger imputed-interest issues that can complicate the installment treatment.

The interaction with subordination matters: an installment-sale-eligible note that's deeply subordinated still benefits from the tax deferral but carries the credit-risk profile the subordination creates. The tax benefit doesn't compensate for a hope-note credit profile, but it does meaningfully improve the after-tax NPV of a well-structured note.

The parent Explainer — Payment Structures & Capital Stack — frames the layer cake. Foundations covers the framework; Forms of Consideration covers the payment forms these instruments document.