The buyer is offering our target purchase price but requires a five-year interest-only seller note with a balloon payment at maturity, arguing that amortizing principal would starve the business of growth capital. How do we structure this note so we are not taking equity risk for a debt return?

Question

Tyler Smith · Accepted Answer

An interest-only balloon seller note leaves your proceeds fully exposed to the buyer's operational risk for five years. If they mismanage cash flow or overleverage the company with senior debt, your balloon payment cannot be refinanced. You are carrying equity-level default risk while receiving a fixed, capped debt return.

To rebalance the risk, negotiate mandatory principal amortization starting after year one or two, funded through excess cash flow sweeps. Under this structure, a predetermined percentage of annual free cash flow must be applied directly to note principal before the buyer or private equity sponsor can take equity distributions or charge management fees.

Second, write in a coupon step-up. If the note is not retired or refinanced by the end of year three, the interest rate should jump by 250 to 400 basis points. This financial penalty strongly incentivizes the buyer to refinance your note rather than treating your capital as cheap subordinate financing.

Third, establish tight cross-default covenants. If the buyer defaults on their senior credit facility, fails to maintain a specified minimum fixed-charge coverage ratio, or undergoes another change of control, the seller note must accelerate immediately. Never allow a buyer to lock up your exit capital without mandatory amortization triggers, clear governance guardrails, and financial disincentives against delay.