# SFSB-6: Underwriting & Credit Best Practices **Seller Finance Standards Board | Published: 2026 | Version 1.0** --- ## Purpose These Underwriting and Credit Best Practices establish the SFSB's recommended framework for evaluating the creditworthiness and investment quality of seller-financed business notes prior to purchase. Sound underwriting discipline is the primary defense against credit loss and the foundation of a sustainable note investment practice. These guidelines are intended to promote consistency, transparency, and integrity in the evaluation and pricing of seller-financed notes, while recognizing that underwriting is as much an art as a science and that reasonable judgment will always be required. ## Scope These guidelines apply to the underwriting of seller-financed promissory notes arising from the sale of small to mid-sized businesses, commercial real property, or business assets. They are directed at note buyers, note funds, institutional and individual note investors, and their advisors. These guidelines do not constitute legal advice, and investors should engage qualified legal and financial professionals in connection with each transaction. --- ## SECTION 1 — PURPOSE AND SCOPE OF UNDERWRITING **1.1 Objective.** The purpose of underwriting a seller-financed note is to answer two fundamental questions: (1) Will the borrower pay? and (2) If the borrower does not pay, can the investor recover its investment through enforcement against the collateral? A thorough underwrite addresses both questions independently, because a borrower's willingness and ability to pay, while critical, does not eliminate the need for adequate collateral coverage. **1.2 Underwriting vs. Due Diligence.** These guidelines distinguish between underwriting (the analytical and credit judgment process) and due diligence (the document verification process described in SFSB-4). Both are required for every transaction. Underwriting must be conducted on the basis of verified information, not borrower-prepared estimates or unaudited projections. **1.3 Primary Source Documents.** The investor shall base its underwriting analysis on primary source documents — including executed financial statements, filed tax returns, appraisals prepared by licensed professionals, and UCC or title search results — rather than on borrower-prepared summaries, broker marketing materials, or third-party spreadsheets. Where a conflict exists between a primary source document and a borrower-prepared document, the primary source governs. --- ## SECTION 2 — BORROWER AND BUSINESS ANALYSIS **2.1 Business Type and Classification.** The underwriter shall identify and document the borrower's NAICS code and industry classification, as this is foundational to benchmarking financial performance, assessing industry risk, and applying appropriate underwriting standards. Industry-specific risks — such as seasonality, regulatory environment, customer concentration, and capital intensity — shall be identified and addressed. **2.2 Minimum Operating History.** The SFSB recommends that note investors apply a minimum operating history threshold of two (2) years for the underlying business. Businesses with less than two years of operating history present significantly elevated risk due to the absence of a demonstrated performance track record and the statistical concentration of small-business failures in the early years of operation. Transactions involving businesses below the two-year threshold require additional compensating factors, such as a stronger personal guaranty, lower LTV, or a shorter note term, to be considered acceptable. **2.3 Revenue Stability and Trend Analysis.** The underwriter shall review two to three years of revenue history to assess stability and trend. Revenue growth is a positive indicator; however, the underwriter shall also consider whether growth is organic and sustainable, or driven by non-recurring factors. Revenue decline exceeding ten percent (10%) year-over-year, or significant volatility across periods, is a material risk factor requiring documentation and justification in the credit narrative. **2.4 Seller's Discretionary Earnings (SDE) Computation.** For small-business transactions, SDE is the standard measure of the business's economic output available to a single working owner-operator. SDE is computed as follows: > **SDE = Net Income (per tax return or reviewed financial statements)** > + Owner's W-2 wages and benefits > + Discretionary owner-related add-backs (non-recurring, personal, or non-cash expenses documented with specificity) > + Interest expense > + Depreciation and amortization > − One-time gains or non-recurring income items > − Capital expenditures required for business continuity (at underwriter's discretion) The underwriter shall scrutinize all add-backs. Add-backs must be documented with supporting evidence. Undocumented or speculative add-backs shall not be accepted. The SDE figure used for credit analysis shall be the lower of: (a) the trailing twelve-month (TTM) SDE and (b) the three-year average SDE, unless a compelling and documented justification supports a higher figure. **2.5 Debt Service Coverage Ratio (DSCR).** DSCR is the primary quantitative credit metric for seller-financed business notes. It measures the adequacy of the business's cash flow to service its debt obligations. > **DSCR = Stabilized Net Operating Income ÷ Annual Debt Service** Where Annual Debt Service equals the sum of all scheduled principal and interest payments due under the Note (and any senior debt obligations of the business) in a twelve-month period. The **SFSB minimum recommended DSCR is 1.25x** (i.e., the business generates $1.25 of cash flow for every $1.00 of annual debt service). Transactions with a DSCR below 1.25x require documented compensating factors and Investor acknowledgment of elevated risk. Transactions with a DSCR below 1.00x — meaning the business cannot cover its debt service from operations — are generally not suitable note investments absent extraordinary collateral coverage or a demonstrated non-recurring explanation for the shortfall. **2.6 Owner Dependency Risk.** Many small businesses depend materially on the skill, relationships, or reputation of a single owner or key employee. The underwriter shall assess the degree of owner dependency and document whether: (a) the business would maintain its revenue and cash flow under a substitute owner; (b) key customer or supplier relationships are transferable; and (c) adequate operational systems and staff exist to support continuity. High owner dependency is a risk factor that may warrant a personal guaranty, a lower purchase price, or additional collateral. --- ## SECTION 3 — NOTE TERMS ANALYSIS **3.1 Acceptable Loan-to-Value (LTV) Ranges.** Acceptable LTV ratios vary by collateral type and risk profile. The following are SFSB guidance ranges: | Collateral Type | Recommended Max LTV | |---|---| | First-lien commercial real property | 75% | | Second-lien commercial real property | 65% (of total encumbrances ÷ value) | | Business assets (UCC first lien, established business) | 80% of stabilized business value | | Business assets (UCC first lien, early-stage or distressed) | 60% or less | | Unsecured | Not recommended; require extraordinary compensating factors | LTV shall be calculated using the lower of: (a) the appraised or professionally estimated collateral value and (b) the original transaction price, adjusted for depreciation or market change where relevant. **3.2 Interest Rate Benchmarks.** Seller-financed business notes should carry an interest rate commensurate with the risk of the underlying credit. A rate that is materially below market — such as one structured to produce a favorable sticker price at the expense of yield — increases the buyer's discount and effectively reduces the seller's net proceeds. The underwriter shall note whether the stated rate appears consistent with prevailing market conditions for comparable credits and whether a below-market rate is a structural feature of the deal requiring pricing adjustment. **3.3 Maximum Term Guidelines.** Note term should be matched to the economic life of the collateral and the borrower's demonstrated debt-service capacity. The SFSB recommends the following maximum term guidelines: - Business asset collateral (equipment, inventory, goodwill): generally not to exceed seven (7) years - Mixed collateral (business assets + real property): generally not to exceed ten (10) years - Real property collateral only: may extend to twenty (20) years with adequate amortization Longer terms increase reinvestment risk, balloon payoff risk, and the probability of credit deterioration over the holding period, and should be priced accordingly. **3.4 Balloon Payment Risk Assessment.** A balloon payment represents the largest single credit event in the life of the note. The underwriter shall assess: (a) the likelihood that the borrower can refinance or pay off the balloon at maturity; (b) the ratio of the balloon to the estimated collateral value at maturity; (c) the borrower's track record and credit profile as evidence of future refinanceability; and (d) whether the balloon occurs in a reasonable time frame that permits monitoring and intervention. Balloon payments exceeding eighty percent (80%) of estimated collateral value at maturity are a significant risk factor. **3.5 Personal Guaranty Requirements.** The SFSB recommends requiring a personal guaranty in the following circumstances: (a) the borrower is an LLC, corporation, or other limited-liability entity; (b) the DSCR is below 1.50x; (c) the business has been in operation for fewer than three (3) years; (d) the collateral is primarily intangible (goodwill, intellectual property, or customer relationships); or (e) the payment history shows any 30+ day late payment. A guaranty from the principal owner(s) of the business is preferred. Guaranty from a non-operating spouse or related party with no independent income is of limited value and should be evaluated accordingly. --- ## SECTION 4 — COLLATERAL ANALYSIS **4.1 Business Asset Collateral — UCC Priority and Liquidation Value.** Where the collateral consists of business assets perfected by a UCC-1 Financing Statement, the underwriter shall: (a) confirm that the UCC-1 is properly filed and has not lapsed; (b) conduct a comprehensive UCC lien search to confirm lien priority; and (c) estimate the liquidation value of the collateral in a forced-sale scenario. The liquidation value — not the going-concern value — is the relevant floor for downside recovery analysis. For asset-intensive businesses, liquidation value may be derived from appraisal; for service businesses, liquidation value of business assets alone may be near zero, making DSCR and personal guaranty coverage proportionately more important. **4.2 Real Property Collateral — Appraisal Requirements.** Where the collateral includes commercial real property, a current appraisal prepared by a licensed MAI-designated appraiser is required. Appraisals more than twelve (12) months old shall be refreshed, or the underwriter shall document the basis for reliance on the prior appraisal (e.g., stable market, no material change in property condition). Desktop appraisals and automated valuation models (AVMs) are not acceptable substitutes for a full appraisal on commercial property for underwriting purposes. **4.3 Lien Position.** The underwriter shall independently verify lien position through a UCC lien search (for business assets) or a title search (for real property) rather than relying solely on the Seller's representation. Second-lien positions are acceptable only if: (a) the combined LTV of all senior and junior liens does not exceed the applicable LTV guideline; (b) the senior lien is current; and (c) the Investor is prepared to monitor the senior lien status and advance funds to protect its position if the senior falls delinquent. **4.4 Mixed Collateral Structures.** Where a note is secured by both business assets and real property, the underwriter shall analyze each collateral category independently before deriving a blended view. Mixed collateral structures can provide additional recovery layers but require more complex lien coordination and should not be underwritten as though the real property coverage automatically compensates for deficiencies in the business asset coverage. --- ## SECTION 5 — PAYMENT HISTORY WEIGHTING **5.1 Significance of Payment History.** Payment history is the single most predictive indicator of future payment performance. A borrower who has consistently paid on time under the note being purchased has demonstrated willingness and ability to pay this specific obligation to this specific creditor — a uniquely relevant data point. Conversely, any pattern of delinquency is a material warning signal that must be addressed in the underwriter's credit narrative. **5.2 Payment History Risk Classifications.** **(a) Clean Payment History (0 late payments):** The note has received every scheduled payment within the grace period from origination through the evaluation date. No credit risk haircut is required solely on account of payment history. This is the baseline expectation for a performing note. **(b) Minor Delinquency (1-2 late payments, all within 1-29 days past due, no current delinquency):** The SFSB recommends that the investor apply an additional pricing discount of approximately five percent (5%) of face value to account for the elevated risk indicated by any late payment history. The circumstances of each late payment should be reviewed and documented (e.g., bank error, holiday timing, one-time financial hardship). **(c) Moderate Delinquency (3 or more late payments, or any payment 30+ days past due):** A history of three or more late payments, or any payment that reached 30 or more days past due, requires additional scrutiny. The investor shall obtain an explanation from the Seller, review the full payment history with particularity, assess whether the borrower's financial condition has improved or deteriorated, and apply a pricing adjustment commensurate with the assessed risk. Discounts in excess of five percent (5%) of face value are typically warranted. **(d) Current Delinquency:** A note that is currently delinquent — meaning a scheduled payment is past due as of the date of evaluation — is a disqualifying condition for a standard note purchase unless: (a) the investor is acquiring the note specifically as a workout or distressed asset and has priced accordingly; (b) a formal forbearance or cure agreement is in place; and (c) the investor has fully evaluated the cost and likelihood of enforcement. Current delinquency shall never be disclosed to a note buyer as "performing." Any note with a current delinquency must be so identified and disclosed under SFSB-2. --- ## SECTION 6 — PRICING GUIDELINES **6.1 Risk-Tiered Yield Framework.** The appropriate yield for a seller-financed note purchase varies with the credit quality, collateral coverage, payment history, and market conditions. The SFSB does not publish specific target yield rates, as appropriate yields are market- and risk-dependent and change over time. Instead, the SFSB recommends that investors develop and apply a written risk-tiered yield framework that assigns target return ranges to defined risk tiers based on the credit factors described in these guidelines. The framework should be reviewed and updated at least annually. **6.2 Fully Loaded Cost Disclosure.** Yield and return calculations shall always be performed on the investor's fully loaded cost — meaning the Purchase Price plus all acquisition costs (broker fees, due diligence costs, legal fees, title/recording costs, and any other costs incurred to close the transaction). Quoting a yield based on Purchase Price alone, while separately charging or absorbing acquisition costs, understates the true cost of capital and misrepresents investment performance. The SFSB requires that any yield or IRR disclosed to an investor, a fund manager, or a reporting party be calculated on the fully loaded basis. **6.3 Prohibited Pricing Practices.** The following practices are prohibited under SFSB standards and constitute grounds for membership review: (a) **Undisclosed Dual Compensation:** A broker or intermediary who receives compensation from both the note seller and the note buyer in the same transaction, without written disclosure to and consent from both parties, engages in a prohibited practice. (b) **Misrepresenting Face Amount:** Representing the Face Amount of a note as the original note principal when, in a partial purchase scenario, the Face Amount is the sum of the specific payments being acquired — or vice versa — is a material misrepresentation. (c) **Yield Manipulation Through Fee Structuring:** Charging fees or requiring credit enhancements that are not disclosed in the yield calculation, thereby making the investment appear more attractive than its fully loaded cost warrants, is prohibited. (d) **Falsifying or Omitting Payment History:** Presenting a payment history that omits late payments, deferred payments, or NSF events, or representing a delinquent note as current, is a fundamental breach of these standards and may constitute fraud. --- ## SECTION 7 — DOCUMENTATION REQUIREMENTS **7.1 Pre-LOI Minimum Documentation.** Prior to issuing a letter of intent or a non-binding term sheet, the investor should have reviewed, at a minimum: (a) the original promissory note (or a copy); (b) a payment history summary; (c) one to two years of business financial statements or tax returns; (d) a description of the collateral and lien position; and (e) the Seller Disclosure Statement (SFSB-2). Investors who issue LOIs on the basis of less than this minimum documentation accept the risk that terms will need to be renegotiated once full documentation is received. **7.2 Post-LOI / Pre-Closing Full DD Package.** Following execution of a non-binding LOI, the investor shall obtain and review the full due diligence package described in SFSB-4 prior to the expiration of the contractual due diligence period. No closing shall occur with material items outstanding from the SFSB-4 checklist unless the investor documents in writing the specific reason for the exception and authorizes the closing. **7.3 At Closing.** At Closing, the investor shall receive: (a) the original wet-ink promissory note, properly endorsed or with an allonge making it payable to the investor; (b) all original Collateral Documents in recordable form; (c) an executed Assignment of Note and Collateral; (d) the complete original payment history; and (e) all items on the Closing Checklist (SFSB-1, Exhibit C). Certified copies are acceptable only where the investor has documented in writing why the original is unavailable and the risk of relying on a copy. --- ## SECTION 8 — PROHIBITED PRACTICES The following practices are prohibited in all transactions involving SFSB member participants and are inconsistent with the standard of care expected of professional note market participants generally. **8.1 Note Splitting Without Disclosure.** Dividing a single note into multiple partial interests and selling each interest to a different buyer without full written disclosure to each buyer of the existence and terms of the other interests is prohibited. Each buyer in a note-splitting arrangement must receive written disclosure of all other concurrent interests in the note and must consent in writing to the shared ownership structure. **8.2 Falsifying Payment History.** Altering, fabricating, or omitting payment records to improve the apparent performance of a note prior to sale is prohibited and may constitute wire fraud or securities fraud under applicable law. Any participant who discovers falsified payment history in a transaction shall have an obligation to disclose such discovery to all parties. **8.3 Undisclosed Prior Assignments.** Selling or assigning a note that has been previously sold, hypothecated, or pledged without disclosing such prior assignment to the buyer is a fundamental title defect and a prohibited practice. All sellers must represent and warrant, as provided in SFSB-1 Section 4.1(b), that no prior assignment exists. **8.4 Dual Representation Without Written Disclosure.** As described in SFSB-3 Section 6, a broker or intermediary that represents both the seller and the buyer of a note in the same transaction without written disclosure to and written consent from both parties engages in a prohibited practice. Dual representation, even when properly disclosed, creates inherent conflicts of interest that must be actively managed. **8.5 Misrepresenting Buyer or Seller Status.** Representing a buyer as an independent third party when the buyer is in fact an affiliate, related party, or controlled entity of the seller, without disclosure, is prohibited. Similarly, any circular or self-dealing transaction structure must be fully disclosed to all parties. --- *This document is published by the Seller Finance Standards Board (SFSB) as a best practice guideline. It does not constitute legal advice. Members and users should consult qualified legal counsel for jurisdiction-specific requirements.* *© 2026 Seller Finance Standards Board. All rights reserved. Members may reproduce for internal use with attribution.*