We are designing an installment sale under Section 453 to spread out our capital gains tax, but we are worried about the buyer's credit risk and our lack of collateral. How do we structure the deal to include protective covenants that tie directly to our quarterly planning and financial metrics without micromanaging the new owner?

Question

Tyler Smith · Accepted Answer

An installment sale structured under Section 453 of the tax code is an effective way to defer capital gains tax, but it exposes you to significant default risk if the buyer mismanages the company. To mitigate this risk without overstepping into their day-to-day management, you must build operational and financial covenants directly into your promissory note and purchase agreement.

These covenants should be objective, measurable, and tied directly to the core metrics you already track. Instead of trying to control their weekly decisions, negotiate covenants based on critical financial health indicators, such as maintaining a minimum current ratio, a debt service coverage ratio above a specific threshold, or a cap on total capital expenditures.

You should also require the buyer to provide quarterly financial packages, including an updated balance sheet, income statement, and cash flow statement, within thirty days of each quarter's end. To ensure transparency, specify that key high-level operational indicators from your legacy EOS® Scorecard must be shared.

If the buyer breaches any of these covenants, it must trigger an immediate cure period. If they fail to cure the breach, the agreement should contain an acceleration clause that makes the entire unpaid balance of the installment sale due immediately, or triggers a step-in right allowing you to reassess the leadership structure using the Accountability Chart. This structures the deal to protect your financial security while leaving the buyer free to run their new business.