We have a valuation gap where the buyer is offering six times EBITDA but we want eight. They suggested bridging this gap with a seller note structured as a mezzanine instrument, but we are worried about the interest compounding and the actual security of this debt. How do we structure the interest rate and repayment triggers in a seller note to bridge a valuation gap safely?

Question

Tyler Smith · Accepted Answer

When a buyer offers a lower multiple than you want, they often suggest a seller note to bridge the gap. This can be a useful tool, but you must structure it defensively to avoid paying what Keith Cunningham calls a dumb tax.

To bridge a valuation gap safely, you should negotiate the seller note as a senior subordinated debt instrument with a market rate interest rate that compounds monthly. The terms must state that payments are mandatory and not contingent on post close company performance or buyer satisfaction. You must also limit the buyer's right of offset, which prevents them from withholding payments based on unsubstantiated claims of pre closing breaches.

From an operational standpoint, utilize your EOS® data to secure these terms. Bring your historical EOS® scorecard metrics to the negotiation table to prove the consistent predictability of your cash flow. This data shows the buyer that the business can easily support the debt service of your seller note without risking default.

Additionally, negotiate an acceleration clause. This clause must mandate that the entire unpaid balance of your seller note becomes immediately due and payable if the buyer sells the company, undergoes a recapitalization, or experiences a change in control. This ensures that you get paid in full before any new equity holders or lenders can strip cash out of the business.