Promissory Note architecture — clause-level enforcement mechanics.

Unlike an earnout (contingent on performance), the promissory note represents an absolute obligation to pay specific sums on specific dates. It operates independently of the agency's operating performance. The note transforms the seller from an equity owner into a creditor — specifically, a subordinated creditor positioned behind the buyer's primary bank lender. Whether that creditor position is enforceable depends entirely on the clauses inside the document.

§ 01 · Interest rate mechanicsBase rate, AFR floor, default rate.

Base rate determination. Market rates for seller notes reflect the unsecured or subordinated nature of goodwill financing. In the 2026 market (Prime at 7.5–8.5%), fixed rates of 7–9% reflect proper mezzanine pricing. A 4–6% rate in this environment is a subsidy to the buyer. The seller note sits behind the bank's senior lien; if the deal fails, the seller recovers 0–10 cents on the dollar unsecured, 20–40 cents secured. The rate must compensate for that risk.

AFR compliance. Rates must exceed the Applicable Federal Rate published monthly by the IRS. If the stated rate falls below AFR, the IRS applies the Imputed Interest rule — recharacterizing principal repayments as ordinary income and creating unexpected tax liability for the seller. Always verify applicable AFR at closing and set the rate above it.

Default Rate. Upon an Event of Default, the note triggers a penalty rate — typically 18% or the maximum allowed by state law. This rate applies to the entire outstanding balance (not just the missed payment) and continues until the default is cured or judgment is satisfied. The Default Rate serves two purposes: incentivizes prompt cure and compensates the seller for elevated credit risk during default.

§ 02 · Repayment architectureAmortization, payment frequency.

Terms generally range from 3 to 7 years, with 5 years as the standard. Shorter terms reduce the seller's credit risk exposure (less time for things to go wrong) but increase the buyer's monthly burden. Longer terms improve the buyer's debt service coverage ratio (DSCR) but extend the seller's risk window — and must be matched to UCC-1 filing renewals (5-year cycle).

An Amortization Schedule must be attached as an exhibit to the note. This schedule shows the allocation between principal and interest for every payment, preventing disputes over how much principal remains at any point. Monthly equal installments are the standard. Quarterly payments are occasionally negotiated but disfavored — they create larger individual payment obligations and longer cure windows.

§ 03 · Enforcement mechanismsEvents of Default, Cure Period, Acceleration.

Events of Default. The note defines specific triggers that allow the seller to escalate collection. Failure to Pay — missed installment of principal or interest when due, the primary trigger. Bankruptcy/Insolvency — filing or appointment of a receiver. Breach of Covenants — violation of the Purchase Agreement's ongoing obligations. Cross-Default — default on any other material debt (e.g., the bank loan).

Cross-Default is particularly important. If the buyer defaults on senior bank debt, the seller note is automatically in default. Without this clause, the bank could accelerate its loan while the seller note remains technically "current," leaving the seller without legal standing to act while the buyer's assets are being liquidated.

Cure Period. To prevent aggressive foreclosure over administrative errors, notes include a Cure Period — typically 10 days following written notice. During this window the buyer can make the payment (plus late fees and interest at the Default Rate) to return to good standing. Default interest accrues during the cure period on the full balance. If the cure period expires without payment, the default becomes actionable.

Acceleration Clause. The note's primary enforcement lever. Upon an uncured default, the seller can declare the entire remaining principal balance immediately due and payable — not just the missed installment. This gives the seller two immediate options: sue for the full balance, or foreclose on the collateral via the linked Stock Pledge Agreement. Without acceleration, the seller is limited to suing for each missed payment individually — an impractical, expensive, multi-year process.

§ 04 · Payment Waterfall and PrepaymentHow every dollar gets applied.

The Waterfall provision dictates how every dollar received is allocated, protecting the seller's collection costs first. Priority order: Collection Costs and Attorneys' Fees → Late Charges → Accrued Interest → Principal Reduction. This structure ensures a buyer cannot reduce the principal balance while leaving fees or interest unpaid. It prevents the scenario where a partial payment creates a false impression of progress while the seller's costs mount.

Prepayment Rights. Standard agency notes allow prepayment in whole or in part without penalty. This gives successful buyers flexibility to refinance or pay down debt early using agency profits. Sellers seeking yield protection may negotiate a Prepayment Premium (1–2%) for the first 12–24 months — compensating the seller for lost interest income.

§ 05 · Regulatory compliance — Usury, Commercial Purpose, Forum SelectionThe fine-print protections.

Usury Savings Clause. State usury laws cap the maximum interest rate. If the contract rate (base plus default) exceeds the legal maximum, the entire note could be voided in some jurisdictions. A Usury Savings Clause automatically caps the effective rate at the state legal maximum, preventing the note from being invalidated while preserving the highest permissible rate.

Commercial Purpose Warranty. The buyer represents in the note that the loan is for commercial/business purposes, not personal use. This exempts the transaction from consumer-lending regulations (TILA, state consumer protection acts, disclosure requirements) that could otherwise apply and create compliance burdens or invalidation risks.

Forum Selection. The note designates a specific court — typically in the seller's home county — where legal disputes must be heard. This prevents the buyer from forum-shopping (filing in a distant or buyer-friendly jurisdiction) and gives the seller the home-court advantage of familiar counsel and courts.

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