We are accepting a junior seller note as part of the transaction, but we want to prevent the buyer from prioritizing their own executive bonuses over our interest payments. How do we structure cash flow sweep covenants in our seller note to ensure we are paid first?

Question

Tyler Smith · Accepted Answer

When you accept a junior seller note, you are taking on substantial credit risk. To protect your interest payments from being deferred while the buyer pays out massive executive bonuses, you must write strict cash flow sweep covenants and operational boundaries directly into the debt agreement.

Negotiate a covenant that limits discretionary management bonuses, distribution payments, and capital expenditures until your scheduled interest and principal payments are fully up to date. Structure a cash flow sweep that mandates a percentage of the business's excess cash flow be used to prepay your note principal if the company exceeds its quarterly V/TO financial targets.

To monitor this effectively, require the buyer to submit a copy of their weekly EOS Scorecard and quarterly financial statements. This operational transparency ensures you can track their cash conversion cycle and spot warning signs before a default occurs.

If the buyer's performance slips, your seller note should include covenants that restrict salary increases for their leadership team and halt any secondary acquisitions. Using the Step by Step Exit framework, you can show the buyer how maintaining these disciplined operational standards protects both their equity value and your debt security. Do not accept a passive position; ensure your junior note has teeth that protect your yield.