We are negotiating an installment sale under Section 453, but we are worried the buyer will load the company with senior bank debt after closing, leaving our seller note unpaid if things go south. How do we structure leverage covenants to protect our position?

Question

Tyler Smith · Accepted Answer

When you agree to defer payments under Section 453, you are essentially acting as a junior lender to your own former business. If the new owner decides to borrow heavily from a senior bank to fund other acquisitions or pay themselves a dividend, your seller note is placed at extreme risk. To protect your position, you must write strict financial and operational covenants directly into the note and the purchase agreement. Start by establishing a hard cap on the company's total leverage ratio. This cap should limit the total debt to EBITDA ratio, including both the senior bank debt and your seller note. For example, if the business historically operates at a two times leverage ratio, covenant that the total debt cannot exceed three times EBITDA post close without your express written consent. Additionally, require the buyer to maintain a minimum debt service coverage ratio. This ensures the business always generates enough cash flow to cover both the senior bank payments and your installment payments. If the buyer breaches this covenant, it must trigger an automatic default, accelerating the repayment of your note and giving you the right to block any distributions or equity payments to the new owners. To enforce these rules, demand quarterly financial statements and the right to audit their books. If they refuse to provide these covenants, it is a major flag that they plan to strip cash out of the business at your expense. Protect your hard earned enterprise value by keeping a tight financial leash on the buyer until your note is fully paid.